Why mutual funds fail at corporate governance

24 JANUARY 2013


Addressing financial planners, advisors, and mutual fund houses at a recent FPSB meet in Mumbai, the Securities and Exchange Board of India (SEBI) Chairman, according to media reports, stressed the importance of proxy voting and the role thatinstitutional investors can play, in cleaning up the mess in much of corporate India. Press reports quote the SEBI Chairman as saying: "I would urge the asset management industry to get proactive in deciding what they are doing about company resolutions and the governance practices in the companies where they have invested. If institutional investors start taking a lead in this direction, I'm sure a large class of retail investors will benefit substantially from this."

A few years ago, at a global conference on Corporate Governance, I heard one of India's most respected fund managers painstakingly show the audience, slide by slide, how his investment decisions followed the practice of good governance.

More recently, participating in an "Outlook for 2013" panel discussion organised by a leading magazine, I heard my panel members pronounce that the "bull" market in Indian equities has not yet begun. The retail investor, they pointed out in unison, is not in the stock market as yet. The "poor" retail investor, they sighed, will come in once the market is really high - and that, they declared wistfully, will be the sig that we have reached the "top" of the market.

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The statements of the fund managers - and the market experts who worship them - hide the honest truth: the "poor" retail investor is "poor" because the fund management industry has made them poor!

When markets were at lower levels, their buddies in the distribution industry were busy selling non-equity products. Why would they want to waste time educating their clients on investing in stocks when the markets are down and out? The distributors - creatures of habit - are focused on their monthly targets: they will sell what is easy to sell.

And the fund managers of the multi-asset houses were almost apologetic that they even had something called equity mutual funds! Their army of sales people were busy touting the benefits of fixed income products.

The Indian mutual fund industry has a history of selling you what is hot - not what is necessarily good for you. In this they are not alone. They are in the same leagues as some of the best names in the financial services industry. Goldman, Sachs confirmed in internal emails that they have to feed bad stuff to the "muppets" (eh, that is a reference to all of us retail investors). Morgan, Merrill, and the big brokers were busy touting bad internet stocks in the US when their internal emails called them a piece of rubbish (to put it mildly). The large banks were selling toxic mortgage products prior to the Lehman bankruptcy. In India, we just went through our ULIP bubble.

We are "poor" retail investors, not because we are dumb - but because our trust and faith has been shattered.

Mirror, mirror on the wall...

In addition to asking the fund managers to look at the corporate governance of the companies they invest in, the SEBI Chairman should ask the fund managers to be fully cognizant of how the assets they manage have been raised.

Corporate Governance is not a convenient yardstick that is to be placed on an Ambani, Birla, Essar, or a Tata as the groups go about building the wealth of the founding families. Nor is it question to be asked of multinationals about to burden the shareholders of their Indian affiliates with sometimes unjustifiably high royalty payments.Corporate Governance is about doing the right thing all the time, not about being selective on when and where to apply it.

So, I hope the fund managers start to investigate how the assets that they manage were actually raised. With all their analytical brilliance and mastery of spread sheets, surely the fund managers and their buy-side teams of analysts can use the raw data available in the public domain on "IPOs" of mutual funds, gross inflows to the mutual fund industry, gross outflows, net inflows retained by the mutual fund industry, and fees paid to distributors to give us "poor" retail investors a hint of what was going on within the industry. And what may still be going on...though to a lesser degree.

Being insiders - and legally this time around - surely the fund managers have access to more specific information on how much their distribution channels got paid, who was sent off for jaunts to Singapore (as a reward for doing what), how their fund houses amortised all these marketing expenses, and - last but not the least - have their products made money for their investors over cycles?

The "poor" retail investor did not become poor because of his stupidity. He became poor because of the blatant mis-selling and bad advice meted out to him over various boom times: the technology, media and telecom (TMT) bubble of the 1999-2000 period; the India shining spin; the sector-fund craze; and the FMP bubble which required a RBI bail out in 2008 (despite a firm "no" from the then SEBI Chairman). And, if you wish to dig deeper, look back at the era of aggressive fund raising adopted in the CanTriple and CanDouble days of the late 1980's and early 1990s, or Unit Scheme 1964, or even the Morgan Stanley domestic fund launch in 1994.

And at each busting of the retail investor, the CEOs looked in the mirror and felt good about themselves: their AuM had increased. Their Sponsors, each with a distinguished ability to inject a minimum net worth of over Rs 10 crore into their AMC "businesses" (that is the monetary qualification to decimate your savings), rewarded the teams in their AMC businesses with larger bonuses and salary hikes.

And the respected fund managers?

They got a share of the surging revenues, too, with their salaries and their bonuses.

And they kept on giving lectures and speeches on Corporate Governance.

Trust gone bust!

The retail investors know that the mutual fund industry is not there to save them.

Indians are buying more gold because they have lost faith in equity - not because they don't believe in the profits of Indian companies. Retail investors know they will see little of those profits as investors in mutual funds. The continuous and persistent decline in mutual fund folios is a fact that stares the industry in the face every day.

The solution to the problems that have plagued the mutual fund industry is not to raise the minimum net worth of mutual fund houses to Rs 50 crore - as the large fund houses are now lobbying for furiously (to have you as their captive audience, my "poor" investor!).

The mutual fund industry is not the solution for good corporate governance, it is the problem.

The mutual fund houses - and their powerful Sponsors - are like reluctant children: fighting and screaming any attempt to control their misdeeds. Think about it: every "good" thing in the industry has come about because SEBI has mandated it - not because the mutual fund industry wanted it! Till today, there has been no apology from any mutual fund house on what may have been borderline legal but investor-decimating acts.

So, yes, SEBI must continue to make decisions that make it safer for investors to enter the stock markets and raise the bar of how listed companies function - but don't expect any help from the mutual fund houses. Ironically, many mutual fund houses may be owned by the very groups that need to improve their governance! ☺

Suggested allocation in Quantum Mutual Funds (after keeping safe money aside)
Quantum Long Term Equity Fund Quantum Gold Fund
(NSE symbol: QGOLDHALF)
Quantum Liquid Fund
Why you
should own
it:
An investment for the future and an opportunity to profit from the long term economic growth in India A hedge against a global financial crisis and an "insurance" for your portfolio Cash in hand for any emergency uses but should get better returns than a savings account in a bank
Suggested allocation 80% 20% Keep aside money to meet your expenses for 6 months to 2 years
Disclaimer: Past performance may or may not be sustained in the future. Mutual Fund investments are subject to market risks, fluctuation in NAV's and uncertainty of dividend distributions. Please read offer documents of the relevant schemes carefully before making any investments. Click here for the detailed risk factors and statutory information"

Disclaimer: The Honest Truth is authored by Ajit Dayal. Ajit is a Director at Quantum Advisors Pvt. Ltd and Quantum Asset Management Company Pvt. Ltd. The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and has not been authenticated by any statutory authority. The author, Equitymaster, Quantum AMC and Quantum Advisors do not claim it to be accurate nor accept any responsibility for the same. Please read the detailed Terms of Use of the web site. To write to Ajit, please click here.


Suggested allocation in Quantum Mutual Funds (after keeping safe money aside)

Quantum Long Term Equity Fund, Quantum Equity Fund of Funds, Quantum ESG India Fund Quantum Gold Fund
(NSE symbol: QGOLDHALF)
Quantum Liquid Fund
Why you
should own
it:
An investment for the future and an opportunity to profit from the long term economic growth in India A hedge against a global financial crisis and an "insurance" for your portfolio Cash in hand for any emergency uses but should get better returns than a savings account in a bank
Suggested allocation 80% in total in both; Maybe 15% in QLTEF and 75% in QEFOF and 10% in Q ESG 20% Keep aside money to meet your expenses for 12 months to 3 years
Disclaimer: Past performance may or may not be sustained in the future. Mutual Fund investments are subject to market risks, fluctuation in NAV's and uncertainty of dividend distributions. Please read offer documents of the relevant schemes carefully before making any investments. Click here for the detailed risk factors and statutory information"

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4 Responses to "Why mutual funds fail at corporate governance"

poonam lalwani

Oct 25, 2017

As i m researcher plse mail me this article

Like 

ratneshwar prasad

Jan 27, 2013

I had invested in HDFC MIP with good expectations but even in rising market returns are around 5 percent.

Like 

Tushar Shah

Jan 24, 2013

Well done Ajit, for a hard hitting article on self serving fund managers and pundits.

The million Dollar question is, other than in Quantum, where do retail investors invest to participate in equity markets? In ETFs?

Like (1)

Mahesh

Jan 24, 2013

Hello Mr. Ajit,
Thank you for writing such an informative article. While MFs are supposed to be the best vehicle to participate in Equity investment for common man, the current problem faced by retails investor is Problem of Plenty. How does a retail investor identify the right MF to invest money in? How do we know that our money is invested prudently? After a lot of deliberation, I decided to invest in Quantum long term equity fund, only to find that this does not figure in any of your recommendations in the service 'fund select plus' offered by PersonalFn which happens to be your group company. Is it to avoid conflict of interest or does it suggest anything else?

Like (2)
  
Equitymaster requests your view! Post a comment on "Why mutual funds fail at corporate governance". Click here!