»The Honest Truth by Ajit Dayal

Never buy a fund because of its ranking

First, a disclaimer.
Actually, a few disclaimers and a general background.

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Never buy a fund for its ranking - I say this even though Quantum Long Term Equity Fund is ranked number 9 out of 183 funds.

Rank as on Sep 09, 2010

Table: 1 Quantum Long Term Equity Fund ranked 9th out of 183 on a 3-year track record basis by MoneyControl.
Mutual Fund SchemeRatingAssets (Rs. cr.)NAV (Rs./Unit)1wk1mth3mth6mth1yr2yr3yr5yr
IDFC Premier Equity - A (G)5 Star1,539.6335.228322385811
ING Dividend Yield (G) Not Rated43.9624.59172457516149247
Birla SL Dividend Yield (G)5 Star528.5289.71178384313232339
Reliance RSF - Equity (G)5 Star3,111.9732.76749878106754542
ICICI Pru Discovery Fund (G)5 Star1,286.1850.3817412315259303537
UTI Master Value Fund (G)5 Star527.3855.631183427241111661
UTI Dividend Yield Fund (G)5 Star2,364.0832.7412980106744718720
Sundaram S.M.I.L.E Fund (G)4 Star747.5836.3220313365849930832
Quantum Long-Term Equity (G)Not Rated60.5822.6110330544337279--
Templeton (I) Growth Fund (G)4 Star735.49126.867117710465511015
HDFC Top 200 Fund (G)4 Star8,610.71213.36125103110688642113
HDFC Equity Fund (G)5 Star7,450.56285.29694951282613113

As many of you may know I am the founder of Quantum Advisors which is the Sponsor of Quantum Asset Management Company, which has launched the Quantum Mutual Funds of which Quantum Long Term Equity Fund is the one I am writing about specifically.

The Quantum Long Term Equity Fund, as many of you may know, chose to stay away from all the fudgy-dodgy-shady dealings between the 28 fund houses in existence as of February 2006 and the thousands of distributors in the country.

Unlike many of the other 28 fund houses in active business when we launched in February 2006, we had no desire to send those distributors who mis-sold the most products to you (putting your savings at risk) on contest-winning trips to Singapore and Thailand or gifting them a car - with your money, without telling you about it!

Nope, rather than be part of a grab-your-wallet scheme, we decided to go "Direct to Investor" in a transparent and open manner.

Quantum was the 29th fund house but the 1st - and I say this with shame (for the mutual fund industry has been more focused on rewarding its employees and distributors), not with pride - to focus on what is good for investors.

And because we had no "distribution channels" working for us, we were left with a simple task: focus on our investment processes, find investors like you who understand the need for simplicity of investing in a world of financial theft, communicate to you the "business" processes that guide our approach to looking after your savings, and talk about the risks we are not willing to take.

An ant marches on its daily path
Over the past 4 years, Quantum Mutual Fund - an ant in an industry where elephants dance to the tune of the powerful distributors - has launched just 6 products.

We have done nothing silly. We don't give a warning message to our sales people to collect your money to meet AuM targets. And we have laboured and done our work.

And, once in a while, we have let out our roars against the falsehood carried in some of the media. Size of assets matter, was one myth. A small fund will never be able to perform as well as a large fund. As of September 9, 2010, the Quantum Long Term Equity Fund was ranked 9 out of 183 equity diversified funds tracked by www.moneycontrol.com/mf/gainerloser. Not bad for a "small fund" that has done better than the "larger" funds managed by the large fund houses.

Small fund houses will die, was another viewpoint advertised in the friendly media, since they cannot afford "risk control" solutions. From what I recall of the mutual fund industry, the biggest bust came from the then largest fund house: UTI. And then there were the others like Canbank Mutual Fund. Just after the bankruptcy of Lehman Brothers in September 2008, it was the big boys of the industry who went pleading for help to the Finance Minister and the RBI. The investments they made in real estate paper was stuck and they could not repay all the corporates and HNIs who wanted their money back. Sure, no one could have predicted the Lehman crisis, but could anyone not predict the outcome of a total mis-selling of the FMP products and the greed for yield that made these fund management houses invest in real estate paper? If the fund managers were not aware of the risks they took by investing in paper issued by the "red hot" real estate sector, then maybe the press should start writing articles about how large fund houses hire complacent fund managers!

And talking about risk control, the press had a one-day story on the HDFC Mutual Fund trader who allegedly front-run client money lying in HDFC Mutual Funds? If there is a bad employee (as there allegedly was in HDFC Mutual Fund) he or she can damage the reputation of an asset management company. And the recent laughable attempt to have a minimum net worth of Rs 50 crore - championed by the larger players of the mutual fund industry and endorsed by individuals of great reputation - would not have prevented the hiring of a rogue trader or a fund manager who did not understand the common-sense risks of investing in real estate companies. Size is no indicator of risk control or the ability to stop fraud.

I do agree, though, that if - God forbid - Quantum Mutual Fund has a bad employee that messes up our reputation it will be more difficult for us to "get over it". HDFC, UTI, and others have the clout and the muscle to "tide over" such difficulties. Witness the power of a Goldman, a Merrill, a Citibank. Time and again they have been exposed to compromise the interests of their clients. Time and again, they have been fined - and allowed to live another day because regulators deem them to be "too big to fail". Your money is not safe because these sort of firms survive - their business model to go after you, yet again, is safe! Remember that!

If rankings were the answer
Would you approve of your daughter-in-law based on how good she looks?
Would your son be blessed by his father-in-law based on how good looking he is?
Would you dis-own a child because they were not good looking or did not make it to some ranking tables?

Yes, you would like members of your family to have certain characteristics. And you would like them to be "successful". But what risks would you be willing to take with your name and reputation as a parent to see the "children" succeed?

--------------------- Do you like the "Quantum way"? ---------------------
If you've been reading the Honest Truth and like what Ajit has to say, we are sure you would be pleased to make our acquaintance.
We are, Quantum Mutual Fund, a fund house that works on a set philosophy - the same philosophy reflected in the Honest Truth - Non-commissions, Transparent Costs, Basic Products, Long Term Investing!
Give us a chance to know you better. We're just a click away!

Do you want your child to be on a Forbes ranking list - if you knew that he got there by bribing his way through and probably a murder on his hand?

Hang on, I am not suggesting that fund managers bribe or murder to get to the top! And nor am I suggesting that people cannot make it on "pure merit".

But I am suspicious of "rankings" because they hide more than they reveal.

And I say this despite the fact that Quantum Long Term Equity Fund is ranked 9th out of 183 equity diversified funds as of September 9th on MoneyControl. One way of looking at it is that the monies invested in Quantum Long Term Equity Fund have done better than Rs 120,000 crore of equity assets in the other 173 funds that were ranked. The monies invested in Quantum Long Term Equity Fund have under-performed Rs 10,000 crore of assets in the Top 8 funds.

Assume I am locked in a room.
No access to a phone.
No internet.
No access to CNBC, Bloomberg, NDTV Profit - and if there were access, I would disconnect it. Nothing personal, but those channels are not conducive for long term investment decisions, they are there to give you information on how to make money every day. And making money on a daily basis is a myth I have long flushed out of my investment philosophy.

After being locked up in a room and disconnected from the "real-time" world, if I was then asked to pick one criteria, just one, based on which I was asked to give my money to a fund house to manage for the next 5 to 10 years (if you don't have a 5 to 10 year view on investing you should not even waste your time investing in mutual funds), I would say: show me the ranking tables with as much history and as much detail as possible.

So, yes, I would study the ranking tables, too.
But I would want to know a lot more than the 2-minute noodle that these ranking numbers are used for by individuals.

I would wish to know about the consistency of the rankings - over different time periods, over different market conditions.

I would wish to know the rationale of the buy and sell decisions: what makes the fund manager deploy my savings into a stock? Is there some valaution methodology, some techinical chart, some market khabbar?

Have there been any changes in the investment management approach? Why were these changes made? When were they implemented? Show me how these changes reflected in the portfolio over time.

How much time does the fund manager spend on my portfolio - on the fund that I have invested in? How many other mutual funds with different mandates does he manage? How does he decide which stock ends up in which mutual fund?

What is the philosophy behind the founder or the Sponsor? Why are they in this business? What is their objective? How do they manage conflicts that may arise? For example, if you are UTI and "owned" by the government, can you sell PSU stocks or refuse to buy any PSUs without facing the wrath of the bosses in the Ministry of Finance? Will a fund manager be allowed to stand by what is best for his unit holders?

Yes, there is more to selecting a fund manager than a ranking table.
I am delighted that Quantum Long Term Equity Fund has given the performance that it has - and that it has the rank that it has.
But, more important than the rank, is the thought process and the research and investment rules that the fund management and research teams follow.

No, you don't welcome the son-in-law home because he made it to some Forbes list; for wealth is transitory.
Just as rankings are.

But you take us home and invest in us because there is a meeting of the minds and an agreement over certain core principles like the assessment of risk and the expectation of returns.

No ranking table will give you the answer.
There are no short-cuts to hard study and analysis.
You must make the effort to understand what you invest in and why you invest.

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.