»The Honest Truth by Ajit Dayal

Was your fund manager bought - or were you sold?
20 APRIL 2012

When news broke that Fidelity was selling its Indian mutual fund business, it did send shock waves across the industry. After all, it is not every day that one of the world's largest fund management firms decides to get out of what is supposed to be one of the most promising countries to do business in.

The reasons for the sale, if press reports and conjectures, are to be believed were many. After 8 years of being in business in India, the "size" of the assets under management for for Fidelity in India was still small by their expectations. Fidelity was just about in the "top ten" in equity assets and nowhere in fixed income and debt assets. Some said that while they had good performance, they lagged the leaders like HDFC Mutual Fund. Further their distribution channel relationships were not as deep as that of the leaders. A SEBI order forcing Fidelity to move all trading and operations onshore (from their Hong Kong office) may have been another contributor to the decision to sell. Well, whatever the reason, the deal is done and there is a new owner.

The buyer, L&T, first entered the mutual fund business with the acquisition of DBS Cholamandalam in 2010. L&T seems happy to have bought Fidelity and Y. M. Deosthalee, the CMD was quoted in the Times of India, "With this acquisition we are one step closer to achieving our vision of being among the top players in the Indian mutual fund industry. This acquisition provides L&T Mutual Fund the necessary scale, products and access to retail customers to grow profitably."

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The Times of India further reported that, "as part of the deal, Fidelity's equity fund management team will work with L&T MF's team for a smooth transition, and move out to Fidelity's fold after the same is complete." The fixed income, marketing, and most of the other support functions will apparently stay on at L&T.

The equity assets for Fidelity were reported to be about 70% of the total assets of Rs 8,900 crore. But the equity team is not staying on beyond some "transition period". This has led to a series of articles in the press about what investors in the equity mutual funds should do in such a situation.

Buying the investor base...

First some background of our business. The "business" of investment management is a strange "business".

Investment managers, at the end of the day, are professionals who believe we have the answers. We believe that the way we do things - the unique approach to investment that we each claim to have - is wonderful for you.

Like a guru who offers gyaan to any shishya, fund managers stand ready to tell you our views and judgements. And our good or bad decisions end up in our track record. Our success or failure, across time cycles, is there for all to see. The funds that we manage take on our imprint, our philosophies and our thoughts.

Just as a doctor or a lawyer builds a "reputation" of being good or bad at their profession, fund managers are professionals who build their reputation across different investment environments.

But, over time, the investment management profession has morphed into a "business" which is designed to create new products and gather assets. Just as the medical profession has morphed into a "health care" business led by higher profits from unnecessary tests.

The businessmen who buy fund management companies for "access to retail customers" do so for three broad reasons:

  • They wish to use the investment management skills of the professional teams to grow the assets at a pace faster than what has been achieved by the old owners,
  • They wish to use the existing list of customers to sell products more aggressively than what the previous owners have been able to achieve.
  • The businessmen want to take over the "profession" and find a way to reach out to more savers and reach deep into their pocket. "Share of wallet" is a well-used phrase in the industry.
A recent article in The Economic Times Wealth (April 16, 2012), highlighted the concern of investors in the Fidelity mutual funds and noted that "for the time being, it (L&T) will retain the services of the fund managers under the erstwhile fund house (Fidelity)...it is not known how long the existing team will be available and when new fund managers will assume responsibility".

... or buying the investment management team?

Well, I cannot tell you what an investor in a Fidelity mutual fund should do but I can tell you what an investor in a Quantum Mutual Fund should do - if we were bought by someone!

Over the last few years, we have been asked by many in the press if we will sell out. Our answer has been the same: if someone came to us and said they liked what we were doing, and would not change anything we do, and they promised to keep us around to continue working the way we do, we would talk to them.

And, as I have said in past interviews, many people have come by to have a cup of coffee - but then they have never come back. After the potentially interested buyers hear our focus on "investing" and our refusal to be a part of the opaque and immoral distribution system prevalent in India, they stop wasting their time with us. Theyleave and never come back. It becomes obvious to them that we are not in the "business" of investment management.

The reason we even talk to buyers is a combination of:
  • a hostile regulatory environment, and
  • a desire to make our services more visible and more available to the growing numbers of savers in India.
Securities and Exchange Board of India (SEBI) has many times flirted with a ridiculous rule that links the net worth of the asset management company to the amount of money that we manage. It is like saying a doctor can only treat a rich patient after he has proven that he himself is rich!

Or that a lawyer cannot represent a rich person, until the lawyer first proves that he is rich. This proposed "net worth" rule is loved by the big boys of the mutual fund industry who would like to keep the club closed to their small, mutually happy group. They want the "business" of fund management to be out of bounds for the "professionals".

Unfortunately, the original authors of this "recommendation" are such stalwarts as Mr. Malegam and Mr Deepak Parekh who, though brilliant and very nice people, have never managed money in their life but were happy to lend their name to an inane idea. An idea that does not appreciate the fact that a mutual fund does not - and should not - guarantee any returns. Unlike a bank or an insurance product. Therefore, a mutual fund needs no capital adequacy ratio, as banks and insurers do.

In addition to the regulatory uncertainty, Quantum Mutual Fund has had to face whispers that a small fund cannot hire smart people. Therefore, it was alleged, the Quantum Funds will not perform well. Or suggestions that not paying any of the opaque distribution commissions will give uszero investors.

After 6 years of busting many myths,Quantum Mutual Funds is doing well from a performance angle and from an awareness angle.

Though our "direct-to-investor" approach has shown a remarkable resilience (see Table 1) despite the turmoil in the industry (which has resulted in the sale or shut down of many fund management companies), there is no doubt that we are "small".

Table 1: Quantum MF grows in a declining industry.
Net inflows of Quantum Long Term Equity Fund (in Rs crore)41233
Net inflows of all equity mutual funds (in Rs crore)595-13,405 (outflow)264
Quantum equity funds, market share of all equity funds0.029%0.043%0.068%

We are still the ant - though we are troubling those giant elephants busy dancing to the tune of the distributors and lobbying with the regulators to allow the opaque distribution models to control the industry.

If a buyer came along (and maybe they will after they read this article J) and promised us:
  • The ability to retain our teams and maintain our investment processes,
  • The ability to continue to run our "business" in an ethical and transparent manner,
  • The ability to showcase our skills and our products to a larger audience,
then, yes, maybe we would talk to them over a cup of coffee and possibly even chat through to dinner and dessert!

Investors in mutual funds should be aware that ownership of the company, of the AMC, is not critical.

Ownership of the research and investment processes is key.

Ownership of the ethics is important.

Ownership of the AMC, in my opinion, is like owning or renting an office. It does not matter whether you own or rent the space you work in - what matters is what you do in that space and how you utilise that space.

Don't be sold, exercise your freedom of choice

So, this is my advice to investors irrespective of which fund house is buying or selling.
  • If the fund management team does not change for at least 3 years after the acquisition, you are safe to carry on with your investment in the mutual fund; if there is no clarity on that, be prepared to exit and redeem. There is no shortage of mutual funds with good track records. There is no reason for you to live with uncertainty and pay fees for doing so.
  • If the new buyer starts launching a series of new products - even though the fund management teams remain in place for three years - then be careful. The focus of the fund management team will likely be nudged towards managing more products and will dilute the time and energy they are spending on the mutual fund you are investing in. Distraction can result in bad performance.
  • If there are changes to the independent members of the Boards of the Trustee Company or the AMC, understand why those changes have taken place. If the board members are truly "independent" then why should the new buyer want to change them? Unless of course, "independence" comes with a hidden loyalty badge!
The typical saver is looking for ways to put aside some money for use sometime in the future. Who manages that money, what processes they have, what ethics drives them, is far more important than who owns the firm. Though who owns the firm will have a bearing on these important criteria.

Mutual fund businesses are being bought for their list of investors. When, actually, they should be bought for the skills of the investment managers.

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Suggested allocation in Quantum Mutual Funds (after keeping safe money aside)
Quantum Long Term Equity Fund 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% 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.