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Does it make sense to follow your fund manager? - Outside View by PersonalFN

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Does it make sense to follow your fund manager?
Aug 18, 2011

In the past many of you investors may have experienced your mutual fund distributor / agent / relationship manager trying to persuade you to invest in a mutual fund schemes, merely because the respective mutual fund scheme is managed by a star fund manager. The punch line you must have heard is - "Sir, invest in XYZ equity mutual fund. It is managed by "Mr Abc" - a star fund manager, and thus is bound to give solid returns." Probably, knowing the fund manager well (due to frequent interaction with the star fund managers at fund management meetings organized for mutual fund distributors / agents), he (your mutual fund distributor / agent / relationship manager) may have also tried to provide you his history and biography, in attempt to impress upon you and try to gain confidence.

And while many of you may have acted upon this luring talk, the question arises whether this a prudent way of investing in mutual funds? Should there be so much emphasis on individualistic fund management.

We are quite sure that many of you under sheer influence of your mutual fund distributor / agent / relationship manager, may concur on the aforementioned view, but then you also need to ask for a track record of performance of all the mutual fund schemes managed by the star fund manager (which your mutual fund distributor / agent / relationship manager has high regards) where you need to check the following:

√ Returns of the respective mutual fund schemes

√ Risk investors are exposed to (as revealed by the Standard Deviation)

√ Risk- adjusted returns achieved by the fund (as revealed by the Sharpe Ratio)

√ Portfolio churning (as revealed by the Portfolio Turnover Ratio)

Moreover, as a litmus test you also need to ascertain how the respective mutual fund schemes managed by the star fund manager has sailed during various market cycles (i.e. during bull and bear phases). Mind you, while your mutual fund distributor / agent / relationship manager may have everything to boast about the star fund manager during the bull phases, the true test of the fund manager (he's promoting) lies during the bear phase. This because the respective mutual fund schemes managed by the star fund manager must display limited downside risk during the turbulence of the equity markets, thereby attempting to protect wealth erosion.

After having done an assessment of the aforementioned points, if indeed the star fund manager has been successful on the above criteria; you need to seriously think what's going to happen to the respective mutual fund schemes managed by him (the star fund manager) when he leaves the organization (for better career prospects, or even when he retires). While this may sound a bit too much of long- term thinking, in our opinion it is imperative if the mutual fund house is not process and systems driven, whereby the fund manager has been given the leeway to manage a mutual fund scheme based on his individual fund management traits. Thus going forward all the starry returns which you vied for (in the past) may not be delivered in the future as the star fund manager quits or retires.

Hence given such a scenario the big question may now pop up - "what do I do?"

Well, in our opinion instead of relying heavily on an individual's fund management trait, it is vital that you give due weightage to the investment processes and systems followed by the fund house. This in turn will help you to reduce the downside risk as investments made (for the portfolio) are process driven, whereby the investment mandates too are followed by the fund houses and the fund manager's role is to function within the parameters defined by the fund house.

It is noteworthy that well laid out investment processes and systems, have a major impact of individual mutual fund schemes perform, and moreover tend to sail well during the turbulence of the equity markets and also when the fund manager quits or retires from his job (this is because everything is defined as per the set investment processes and systems, along with the mandate which the respective funds follow).

Thus, getting the fund house which follows strong investment processes and systems, is the first, right and very important step in making a prudent investment decision in mutual fund investing.

We recognise that today with 43 mutual fund houses in existence the task can be daunting, but to provide a perspective herein below are some points which you need to evaluate while selecting a right fund house and strong process & systems driven fund house:

  • Fund management experience: You should always prefer a fund house with vast experience in managing investors' hard earned money, over one which is relatively new. The fund house's vast experience helps in assessing its ability to tide over even during the turbulence of the equity markets, thus proving it to be a resilience test.

  • Research process: A fund house with a dedicated research team backing its investment decision is a plus point, over a fund house which lacks research intelligence, and the one who believes in momentum playing (or to say so the khabar in the market). Moreover one needs to assess the research process and system which is involved while building- up the portfolio for respective funds.

  • Asset managers v/s asset gatherers: In the past, banking on the positive investor sentiments many fund houses launched new schemes, but there weren't really unique in nature. You need to be wary of such fund houses as new scheme(s) introduced add up to work load for fund manager(s), thus also having impeding impact on the existing ones which he manages as well. It is noteworthy that a mutual fund house is regarded as a fund management entity which needs to take utmost care while managing investor's hard earned money. Hence, unnecessary product launches (by respective mutual fund houses) need to be underweighted an focus should be on fund houses who aren't indulging in unnecessary product launches, but rather managing investors hard earned money prudently.

  • Investment philosophy, processes and systems: As an investor you need to delve a little deeper in understanding a fund house's investment philosophy, which can also help you ascertain the investment processes and systems it follows (along with the mandates for the respective mutual fund schemes). As mentioned earlier, the investment processes and systems have to be robust thus helping you investors create wealth in the long- term, where even the exit of a star fund manager will have a negligible impact on your investments.

  • Investor service and transparency: Services offered by mutual fund houses may vary. Some fund houses are more investor friendly and transparent than others. For instance, some funds do not disclose their portfolio turnover ratio on a regular basis, thus precluding you to check the churning which has occurred in the portfolio.
Remember, your fund manager has no magic wand. And even if he does, over- dependency would not be the right approach. It is vital that you give due importance to the strong investment processes and systems the fund house follows, as that is eventually going to help you create wealth in the long- term.

PersonalFN is a Mumbai based personal finance firm offering Financial Planning and Mutual Fund Research services.


The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

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