• JUNE 9, 2000

The Fund Manager's Dilemma

To say that managing a fund is a Herculean task is an understatement. It's a task riddled with complexities involving investments, (lots of it), investors (lots of it) and expectations (lots of it). And a letup on any single front is unacceptable.

Lets first understand what a mutual fund is, before we get down to understanding issues from the fund manager's perspective. What is a mutual fund? The textbook definition reveals that 'a mutual fund is an investment company run by professionals with a common investment objective, wherein investors pool in money to realise those objectives'.

The definition is plain and lucid, but does not give the investor an inkling about the fund's duties and responsibilities to its investors. A mutual fund isn't simply about managing investments. It's a lot more complex than that. In an interview to personalfn.com, Mr. Suraj Mishra, (Vice President Prudential ICICI Asset Management Company) put it very aptly when he said, 'a mutual fund is not just a financial product. A mutual fund is a surrogate investment avenue in equities and debt and involves a range of services like marketing and distribution, managing expectations, customer centricity, etc. If its just a question of managing funds, you have portfolio managers doing that, but a mutual fund's functions are much broader.' This is the underlying definition of mutual funds, one that seeks to explain the textbook definition.

From the fund manager's perspective, perhaps the most difficult function of a mutual fund is not managing investments, but managing investor expectations. Fund managers believe that investors expect them to give superlative returns day-in and day-out. This puts added pressure upon them to perform day after day, week after week. It's the cricketing equivalent of a 100,000-strong spectator turnout in the Eden Gardens expecting Sachin Tendulkar to slam every ball out of the ground.

Lets first examine this perception problem a little more closely. Is this perception really true? Do investors actually expect the fund manager to be bang-on-target with every investment decision, churning out exceptional returns month-on-month? Mr S. V. Prasad, President Zurich Asset Management Company (India) P. Ltd. does not think so. Mr Prasad believes that investors don't really have such unrealistic expectations from their fund managers.

To a query posed by personalfn.com about the unrealistic expectations arising out of the daily NAV system, Mr. Prasad had this to say:'I don't agree with this perception. Pressure on the fund manager comes from the philosophy of the fund. We (at Zurich India) never claim that our fund is the best performing fund day-in and day-out, which is impossible. We just claim to offer consistent returns and try to be in the top quartile of funds in that category. This reduces pressure on the fund manager considerably. Sometimes we may not make the top quartile due to a wrong call or an error of judgment, but investors aren't really disturbed with that. After all investors are looking for consistency in returns and capital preservation. When they don't get that, then they are really disturbed.'

That seems to have put the perception problem in the correct perspective.

However, that is not to say that all the pressure on the fund manager is make-believe. Another very difficult (and thankless) task of a fund manager is managing the constant influx and exodus of investors, which happens every day. Unfortunately this is a problem that few investors actually understand. And this is something that investors need to understand, as it concerns them as well.

As explained by Mr Sandesh Kirkire (Vice President - Fixed Income, Kotak Mahindra Asset Management Co.) in an interview to personalfn.com, everyday the fund manager has to deal with three categories of investors. The first category includes the investor who is exiting the fund. The second category consists of the investor entering the fund, while the third category involves the investor who remains invested in the fund.

As the fund NAV is finally the reflection of the price of the assets that it holds, to be fair to all these three categories of investors it is that much important to price the assets in a fair manner i.e. price it at a level, which is realisable in the market place. We have seen in the past the NAVs of Income funds going up inspite of the rise in interest rates. This has primarily happened due to not marking to market the assets of the fund. In such a scenario those investors who have exited the fund at the higher NAV are actually taking away the wealth of the investors who stay back in the fund. Further those investors who enter the fund at such time are actually paying more for the assets than their market value. Thus the fund in effect has penalized both the investors viz. those which are entering the fund as also those who are already invested with the fund. It is this concept that each investor needs to correctly understand while investing into any fund.

Another reason why fund managers dread a falling market is due to the circuit system, which does not allow a stock to move up or down by more than 12% (earlier 8%). So when stock prices are crashing and redemption pressure is at its peak, a fund manager could be stuck with stocks, which he cannot offload if the stocks are languishing at the downward circuit. If this happens for more than 2 days with a substantial number of the fund manager's stocks, he will have to think of some ingenuous ways to pay off investors who have lined up outside his office for their redemption cheques. (Attempts by SEBI to do away with the circuit system for Index stocks could bring some much-needed relief to fund managers).

So like in all cases there are bouquets and brickbats for the fund manager. And in the last couple of months, there haven't been too many of the former. Investors need to understand the issues highlighted above before entering into a fund. They need to understand the philosophy of both - the fund and the fund manager, and most importantly they need to understand the Fund Manager's Dilemma.

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