Is Your Mutual Fund a Risk To Your Life? - The Honest Truth By Ajit Dayal

Is Your Mutual Fund a Risk To Your Life?

27 FEBRUARY 2019

We have all seen the SEBI-mandated disclosures that warn us MUTUAL FUND INVESTMENTS ARE SUBJECT TO MARKET RISKS.

Given the perpetual innovation by many manufacturers of mutual funds to dupe investors with misrepresenting their fund offerings, it is debatable whether these 8 words have really helped us become better investors in mutual funds. Recall that supposedly safe "liquid" funds built risky portfolios that accounted for nearly 30% of all investments in NBFCs like IL&FS and Dewan Housing Finance - to name a few troubled entities. Manufacturers of mutual fund products gave a high level of altitude sickness to trusting investors with a plethora of "balanced funds". In actual fact these "balanced funds" were mostly unbalanced and served the sole purpose of fattening the bank balances of those who marketed and managed these mutual funds. Despite all disclaimers, many in the mutual fund industry continue to find ways to separate you from your wealth. Yeh to sahi hai!

In addition to this well-documented risk disclosure dictated by SEBI and the risk of dealing with the mutual fund industry, we should be aware of a new risk. When making an investment in a mutual fund, investors should consider this very real, evolving - and increasingly more relevant - warning: AN INVESTMENT IN YOUR MUTUAL FUND COULD BE A RISK TO YOUR LIFE - 0R A RISK TO YOUR WAY OF LIFE.

To elaborate on what I mean, let's take two examples:

(1) ITC, Market Cap, approx. Rs. 330,000 crore. Profit as of March 31, 2018: approx. Rs. 12,000 crore

Cigarette smoking is deemed to be dangerous your health. Even if you don't smoke, being around cigarette smoke and inhaling the fumes ('secondary smoking') can be dangerous to your health. Yet, ITC - one of the tobacco companies that manufacture cigarettes in India - is widely owned by mutual funds. The business of harming your lung each time you inhale that burning nicotine is so addictive that - even though governments have banned the advertising of cigarettes and have ensured that cigarette manufacturers print gruesome images of the impact of nicotine on your lungs - the demand for cigarettes continues to rise. That is addiction: despite a danger to your health, you keep repeating the same act. Abetting suicide is a criminal offence under the Indian Penal Code. Providing the material to harm oneself has, so far, avoided this section of the IPC.

Driven by this consistent demand and the ability of companies like ITC to price their products to offset the high taxes imposed by governments, fund managers have rushed to invest in ITC. The consistent, recession-proof profits are too hard to resist. Investment is known to be about seeking returns and, whether this results in lung cancer or not, is not the concern of fund managers. ITC has been a darling of the stock market. As a matter of full disclosure, the investment companies that I am associated with (Quantum Advisors and Quantum Mutual Fund) do not own 'sin stocks': companies in which over 80% of revenues originate from tobacco, gambling, or alcohol. During our training as long term "value" mangers with the late Tom Hansberger (co-founder of Templeton, Galbraith and Hansberger - now morphed into Franklin Templeton), we were also asked to consider "values" in our investment process. We owe much of what we learned in our research and investment process to our years of working with Tom. But "the times-they-are-changing" sang Bob Dylan. It is getting more complicated in a globalised world to identify rights and wrongs on many fronts, including on issues to do with the environment - and invest accordingly. Which take me to the next example: Larsen & Toubro.

2) Larsen&Toubro, L&T, approx. Market Cap Rs. 177,000 crore. Profit as of March 31, 2018: approx. Rs. 8,600 crore

One would never associate an engineering and construction company with death. Yet, Larsen &Toubro may be inadvertently getting more deeply involved in that business. Not only is L&T intent on increasing its focus on being in the 'business' of defense (weapons in the wrong hands, as you are aware, can kill even as it 'defends') but L&T has now been awarded the contract to build a part of the Rs. 12,721 crore, 10 km stretch of the coastal road from Marine Drive to Worli. L&T's contract, as per an article in The Hindu (October 9, 2018) is from Haji Ali to Priyadarshini Park. The Maharashtra State Road Development Corporation (MSRDC) will oversee the Rs. 7,000 crore, 17 km stretch from Versova to Bandra Sea Link portion in northern Mumbai. This new sea link is 3x the existing sea link and will have a toll of Rs. 250 for cars. As an aside, the project for this has been won by Anil Ambani's Reliance Infrastructure and Astaldi, an Italian bridge construction company.

So, in effect, this new "north" and "south" coastal road will be built at an estimated total cost of Rs. 20,000 crore. L&T's revenues from this project may be Rs. 6,500 crore and assuming a 15% profit contribution, L&T could add Rs. 975 crore to its profit before tax over the life of the project - probably about 3% to 4% of the total net profits that the company earns on average each year.

So, how is the construction of the coastal road a pathway to death? India is a signatory to the Paris Accord on Climate Change (signed in 2016) which recognizes that there is a real danger of climate change and rising water levels on coastal cities. For those who witnessed the July 26th, 2005 deluge in Mumbai and were impacted by the over-concretisation of Mumbai, the construction of such a coastal road along the sea front of Mumbai should be a cause for concern because many independent environmental experts have voiced their dissent for this project. The environmental groups argue that the construction of this coastal road needs a detailed review of the impact of change in tide patterns due to reclamation of land, the impact of the elimination of mangroves, and a full disclosure on how this new road will defend against future coastal erosion. These studies must be done before the roads are built, not after they are built!

Governments continue to speak with forked tongues: on one hand the government representatives talk about encouraging solar power to fight climate change and, on the other hand, they are busy building near the coasts and have conveniently diluted the norms of the Coastal Zone Regulations to encourage coastal-hugging construction. This may potentially please the real estate developers and result in new wealth creation for a select few.

At a more local level of resolving transportation bottlenecks in Mumbai, the BMC refuses to pay the BEST the Rs. 600 crore subsidy every year so that the BEST can continue to clock nearly 3 million commuter rides every day - but the BMC is willing to spend Rs. 12,000 crore on the toll-free "southern" coastal road project so that the wealthier population who have cars pay no toll to use it. The BMC will run up a maintenance bill of a few hundred crores of rupees every year to move an estimated 0.3 million per day on the coastal road. Spending a lot more money to move fewer people sounds like a bad idea. And cars add to pollution, they don't reduce it! Furthermore, if the objective is to help ease congestion, encouraging the creation of more frequent and better bus services seems a far more logical path that ramming through a coastal-road project.

This project, born under the Congress-led Chavan state government and accelerated under this last year of the current BJP-Shiv Sena Phadnavis-led government, will impact the lives of millions of residents of Mumbai. The state governments technically have no control over how the BMC spends the money, yet the successive Chief Ministers of state governments have imposed their will on a willing BMC. The BMC has obliged. From the Rs. 30,000 crore annual budget of the BMC, Rs. 1,200 crore has already been earmarked for spending this past year. While the merits of this project can be decided by the voters and the courts but you as a citizen have a fear about the project, there is something that you - as an investor in a mutual fund - can do today.

L&T is a widely held stock and is owned by many mutual funds - including Quantum which owns L&T stock on behalf of its clients and investors.

First, to remove any allegations of a selfish motive, a disclaimer: I don't live alongside the route of the coastal road so I have no direct gain/loss of potential property value from the completion of what seems like an ill-conceived project probably designed to potentially enrichen the all-powerful political-developer class. I don't have to be a scientist to ask the common-sense question: In an era of significant and rapid climate change (by the evolutionary time-lines of planet earth) will this coastal road have a major impact on how the city of Mumbai will face another water deluge, either from a July 2005-like monsoon event or from the fact that ocean levels are likely to rise over the next few decades?

In 2015, Chennai saw the impact of excessive building and we were haunted by images of its airport and runway being shut down for days due to water-logging. The disruption of human life due to a potential natural disaster was compounded by a possible combination of: (i) engineering folly, (ii) disrespect for the environment, and (iii) human greed.

So, in an era where we all need to be more concerned about the long-term impact of investment decisions made for near-term gains, what can an individual investor do?

Frankly, you can do a lot!

You can help fight what you don't like with your investment - no matter how small it is.

One vote, when compounded by the power of a voting population, can topple governments and elect new leaders.

A few thousand rupees of your investment in any mutual fund, when compounded by the power of tens of millions of other investors in mutual funds, can force those who make business decisions to take account of the long-term impact of short-sighted construction contracts.

Based on data from Bloomberg, many mutual funds and the omnipresent LIC own shares in L&T. To name a few: LIC owns 17%; HDFC Mutual Funds own 4%; Blackrock mutual funds own 2%....

One way to look at this is that your money invested in a HDFC, Blackrock, or Quantum mutual fund is being used by your fund manager to potentially risk your life - and of those around you.

Your investment in your insurance policy in LIC is being used by the insurance company to potentially risk your life - and those around you.

Connect the dots: you invest in a mutual fund for returns; the fund manager invests your money in L&T shares; you get your returns when the stock goes up. But, are you also - inadvertently - adding risk to your life, to your lifestyle, and to your surroundings?

Make your conclusions on this - and act accordingly.

We have made ours: Over the past few years, unknown to many investors in our Quantum Long Term Equity Value Fund, we have taken up issues with the managements or founders of many companies including the venerable Infosys and Tata - and the likes of Ranbaxy, ICICI Bank and Yes Bank. Now, we are engaging with L&T and trying to find out whether they have conducted any studies to show the impact of the construction of the coastal road on the potential environmental damage to the city of Mumbai. If L&T was asked to build a nuclear power plant at Churchgate station, would they not wish to do a study that shows the impact of such a power plant on the city of Mumbai? So, why not for the coastal road which may be a silent killer?

The fund managers of HDFC Mutual Fund, Blackrock mutual fund, Quantum Mutual Fund - and others who are shareholders of L&T - must ask the Board Members and the CEO of L&T the following questions:

  1. Like any other EPC contract, L&T has to give guarantees on the work it has been asked to do. Has L&T given such guarantees or not? What are these guarantees? Are any of these guarantees linked to erosion and coastal flooding that could impair the work that L&T has done and, therefore, have the guarantees invoked so that L&T has to compensate the BMC?
  2. Has L&T given such guarantees to BMC? On what basis? On the environment report of the BMC or on an independent environment report? Publish this - not only are we shareholders but we want to know the impact on the city of Mumbai.
  3. People's lives are at stake. L&T says they are listed as a sustainable company following good practices on the Environment, Social, and Governance (ESG) factors by the Dow Jones Company. How does this project impact that rating? Will Dow Jones strike L&T of this hallowed list?
  4. As a shareholder of L&T, LIC, HDFC mutual fund, Blackrock mutual fund, Quantum mutual fund - and other mutual funds must give L&T an ultimatum: respond and engage with us or we will sell your shares in the market.

A coastal road sounds innocent - but it may not be. And it is for L&T as a company which claims to be responsible and worries about "sustainability" to give its shareholders the comfort that such a project will add to the near-term profit of L&T and will not have any impact on the residents of Mumbai.

Unless L&T can do that, you should call your mutual fund house and tell them that you will redeem all your investments in the mutual funds and in the ULIPs if they continue to own L&T stock. That will make the fund managers take notice and act.

It is your money - and it is your life that may be at risk. Ask those who manage your money to act responsibly - or else redeem your money from those mutual funds.

Yes, it may be time for the new disclaimer on all mutual fund products: AN INVESTMENT IN YOUR MUTUAL FUND COULD BE A RISK TO YOUR LIFE - 0R A RISK TO YOUR WAY OF LIFE.

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

Quantum Long Term Equity Fund and Quantum Equity Fund of Funds Quantum Gold Fund
Quantum Liquid Fund
Why you
should own
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 20% in QLTEF and 60% in QEFOF 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 Founder of 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.

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3 Responses to "Is Your Mutual Fund a Risk To Your Life?"


Mar 9, 2019

I appreciate the article. Simple example, Coca-cola held by Buffet(Most investment advisers swear by this name) over the years. It causes diabetes and what not. Most investors know Sin stocks. And if you're talking about investment then do not preach morality. They seldom go hand in hand. As most businesses are harmful in one way or another. Find something else to write better.


Nelson D'Souza

Mar 1, 2019

Did the fund manager of Quantum Mutual Fund ask the Board Members and the CEO of L&T the four questions in the article? If yes, what is their reply. If no, what is the plan of action.


P.V.Subba Rao

Feb 28, 2019

I have been an Equitymaster subscriber for many years now and eagerly await Mr.Dayal's article " The Honest Truth". I respect and appreciate his investment philosophy and in general his outlook towards worldly matters that impact investments. There are very few top investment professionals who take the moral stand that Mr.Dayal takes.

However, I have to say that this article stretches the morality argument very thin and far. I am aware of the "sin stocks" tag. If one is willing to stretch the definition, then a lot of companies - not just those tobacco/alchohol/gambling - can be said to cause harm to human beings in a gradual manner. What about companies in the fast food business that offer products that are addictive and are known to cause lifestyle diseases, what about automobile companies manufacturing the traditional fossil fuel based vehicles that lead to emissions, what about social media companies that can indirectly be blamed for the increasing toxicity in the public interactions these days. What about NBFCs which charge usurious interest rates on unsecured loans ?

Companies like ITC or L&T or any other "sin companies" are running legal businesses. ITC did not discover tobacco or invent the habit of smoking and smoking is a legal activity across the world. So, I am not sure how investment is such an organisation can be deemed unethical. I do not think anyone is forcing anyone to smoke (my father has been a smoker for 50 years now). On the contrary people of sound mind make a conscious choice to smoke or consume alchohol inspite of a multitude of sources trying to wean them off these habits.

And if being in the defence segment is wrong, then are we to assume that serving in the security forces in the defense of the nation, is also wrong ? I think I have been able to put across my point of view.

If an organisation is upto something illegal or if the organisation indulges in malafide acts to further it's interests, then there is a definite case to stay away from such investments. If we have to view businesses from a purely moral platform, then most companies would fall out of the investment basket.

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