This article was written for Moneylife magazine (http://moneylife.in/article/81/10646.html)
PAYMENT FOR PERFORMANCE? IS IT A MYTH?
Fund managers are a revered kind. There are too few of them (excluding the millions of self styled investment experts) and the good ones do not like to be seen or heard. When the term ‘fund manager’ is used, what image does one form? An expert, who knows everything about every stock, every company and also knows which stock will go up or down including when. He is Warren Buffett and George Soros rolled in to one. Long term investment is the philosophy without missing a single short term play.
There are over thirty five fund houses, a dozen odd insurance companies and a few hundred licensed portfolio managers. In addition, we have thousands of ‘investment advisors’. In addition, we have a few more thousands of ‘technical’ analysts, who look at prices as they move tick by tick and forecast the likely outcomes over the next instant to a few months.
So, what is it that we expect when we give money to a fund manager? When we put money in a mutual fund, we are either choosing a ‘star’ fund manager or putting our faith in the fund house, without bothering about who the fund manager is. Whilst the statutory warning does say ‘past is no indicator of the future’, we do lay a high emphasis on track record. The second issue is one of paying fees to the fund manager. The industry structure is such that the payment does not seem to reflect performance. We pay fixed fees (in case of mutual fund industry) whether the fund house performance is in the top ten or the bottom ten. Often we are hustled in to a decision without getting sufficient time for analyses or thought. In case of portfolio management schemes, the situation is even worse. The manager takes a fee plus a share in your gains based on a ‘hurdle’ rate, which can be even a single digit number. In many cases, even if the PMS Manager delivers returns far below the market, you may have to pay him a ‘bonus’ for beating the hurdle rate! And in some cases, the PMS Manager may first lose a large part of your money (taking only his fixed fee for this splendid performance) and then when he recoups the losses, he may actually end up earning a bonus! It is a funny industry.
Let us now look at what is it that we should be expecting from a fund manager? To me, the first task that I expect from a fund manager is that he should be able to give me a higher than market return, to earn any fee at all from me. If I can buy an ETF and get market returns, the fund manager has to first clear this hurdle to earn anything at all. Otherwise, he has no business to be called a ‘fund’ manager. And, in a falling market, his expertise should enable me to preserve capital as far as possible. If he says that he lost only twenty percent of the money when the market fell twenty one, does he deserve a fee? Probably yes, but I would be reluctant to pay. If the expert cannot tell me when to get out, he is not an expert.
I see many fund managers who say that it is their ‘mandate’ to stay invested. I have an issue with this. A fund manager can miss some or most of a run up, if he is able to articulate that he is not comfortable investing at those levels. Surely, no one comes in expecting the moon. Of course, if there are such people, I have no truck with them. Greedy people do not deserve any sympathy or explanations.
So, what is it that I expect from a fund manager? There are many possibilities:
i) To give me a ‘better’ than market return. I am willing to go along with the ups and downs of the market. I am focused on the long term. So, to take any fee from me, the manager has to deliver better than market return’
ii) To give me a return ‘better’ than the most obvious fixed income return. For instance, I want a better return than a bank fixed deposit or a company deposit. Here, my interest is in preserving capital, but the returns are important to me. The investment is treated as an ‘earning’ member of my financial family. I know that there is a ‘theoretical’ risk of my losing some money, but think that it will not happen to me. Typical investments could include Fixed Maturity Plans (if I am very conservative) and Monthly Income Plans (Am a little ambitious);
iii) To give me a ‘decent’ return. I am not too bothered about beating the market, but am willing to give it to any manager who can deliver, say, twenty or thirty percent per annum. Here, my faith is more on charts and figures, with a ‘stop loss’ discipline (stop loss sounds good to me, but I know that in Indian markets, the stop loss limits are only a figure of speech). Here I am willing to pay a negotiated fee plus an incentive if the manager meets my goals;
iv) To absolutely ‘preserve’ my capital. Zero risk tolerance, because I need the money soon. Instead of it being idle, I want it to earn something. A fixed deposit is a good choice, but liquidity and tax is not very friendly. So, I choose a ‘liquid’ fund. No FMP for me, because exit in between would normally have a penalty; and
v) I am a compulsive gambler. I want the benefit of leverage. So, I give my money to a ‘derivatives’ fund manager, who can multiply my money manifold. Hopefully, give me double every time I check my portfolio. Here, I know that I run the risk of losing my entire stake. If it is going to bother me, I should not be here.
So, there are fund managers for every need. Should all of them be paid uniformly, irrespective of performance as well as meeting goals? In any case, if a fund manager does not generate excess returns over any passive investment, he should not be called a ‘fund’ manager. In fact, any fund manager who gives a return worse than the market, deserves to enter the Hall of Shame and be called a ‘Fund Damager’.
The regulator has already taken the first steps on the ridiculous fee levels being charged under Portfolio Management Schemes. Hopefully, it will also prescribe some qualifications required for someone to manage funds. We are probably the only market in the world where a distributor needs to pass an exam and absolutely no qualifications required for someone to become a fund manager. Fund houses that care about their image and investors generally put in good fund managers in place. I cannot say that same thing for many mutual funds as well as for Portfolio Managers. And another thing that bothers me is the number of schemes that a single individual manages. If I have to manage several schemes with different objectives, I cannot do justice to all. Someone is bound to suffer. This can be clearly seen that if you see the performance track every quarter, the top ten keep churning. Consistency suffers. And once a fund house loses its predictability, marketing becomes a seasonal affair. Marketing pushes the fund only when the rankings look good.