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Mutual Funds seem to be seeking little 'value' - Views on News from Equitymaster
 
 
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  • Dec 23, 2009

    Mutual Funds seem to be seeking little 'value'

    There are often talks that value investing worked many years ago when markets were less efficient. Now, with the amount of research that goes into stocks and the amount of new players that have entered the market, value investing has much less scope to unearth bargains. Or so the theory goes.

    The chart that you are about to see next is one that will confirm to you that the above is nothing but hogwash.

    But first, a brief primer on mutual funds. Out of the money that you invest in them, equity mutual funds hold a percentage this in cash. The rest they invest in stocks. A small part of this cash holding is out of compulsion, as they have to meet obligations from investors who seek to redeem their units from the fund. However, a larger part of this cash holding by a fund has a lot to do with how the fund manager thinks the markets will perform going forward. If he thinks that stocks will go down, he will sell some stocks and thus increase his holding of cash. Similarly, if he feels that markets will move up, he will by more stocks and consequently the fund's cash holding will go down.

    However, as the following chart shows, they can be quite bad predicting the direction of the market.

    Data Source: Value Research Online, Prowess

    The chart plots the monthly cash holdings of the mutual fund industry as a percentage of their assets against the monthly low of the BSE Sensex for the past one year. The results are quite interesting to say the least. For as stocks got cheaper, mutual funds sold more stocks and increased their cash holdings to unprecedented levels.

    So in effect, as Indian companies became cheaper to buy, Indian mutual funds were actually selling them instead of buying more of them. Quite the opposite of what they should have been doing. And this logic defying act was repeated by them on the way up too.

    As markets have risen higher and higher in the last six months, and consequently stocks became more and more expensive, mutual funds have been buying them with full vigour. Infact, their cash levels have now fallen to extremely low levels once again.

    Infact, cash holdings of diversified equity funds averaged around 5% to 6% of total assets in October-November 2009, levels that were last seen during December 2007 and January 2008 when the markets were at their peak.

    Indeed. Buy high and sell low seems to be their mantra!

    But that's not such a bad thing afterall. It shows that most large mutual funds to this day commit the same mistake they have been committing for the last century or so. And in the process, they leave doors of opportunity wide open for those smart investors who realise that you should buy your stocks as you buy your groceries, not as you buy perfume. The cheaper the better.

    Do not be surprised if markets tank sometime in the future and you see mutual funds selling once again. Just stick your neck out and look out for those bargains that will once again be yours for the taking.

     

     

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    4 Responses to "Mutual Funds seem to be seeking little 'value'"

    Anand Kumar

    Dec 26, 2009

    The conclusions drawn from this chart surprised me. This article hides lot of facts. You could not make much sense out of this chart for the reasons added by previous visitors of this article.

    Looking forward to see more interesting content on your site.

    Like 

    Kamesh

    Dec 25, 2009

    Another view-could be that MFs might be driving the market-and MFs buying might cause the market to go up, while MFs selling could cause the market to go down.

    Like 

    Akash Sethia

    Dec 23, 2009

    In part this behaviour is also a reflection of retail investors behaviour who invest in MFs.

    When market tanks - and hence the MF NAV tends to fall, often retail investors tend to redeem. There is no other way for the fund manager but to sell.

    On the other hand investors feel more confident of investing in a rising market scenario. So MFs attracts more money in such circumstances. Now it is better to buy regularly then sitting on a heap of cash not generating enough returns. Isn't it?

    I guess a better way of looking at this behaviour will be to chart the same data of only the top 10-15 funds by size. These are Funds that can consciously avoid the trap because of their size.

    Like 

    Parag Saraiya

    Dec 23, 2009

    Some of this can be explained by the fact that
    When holdings of MF start appreciating (from Mar 09), even if MFs does not buy any more, cash as a % of their asset will become low.

    But most MFs will display herd mentality while buying and selling. Their result will also suffer because of so much of diversification that they end up doing either as a strategy or limits imposed upon them.

    Like 
      
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