Over the last few years, the domestic mutual fund industry has grown by leaps and bounds. Several asset management companies have established base in the country and there are more on the way. Expectedly, the gamut of mutual fund offerings has grown as well. While few would dispute that the mutual fund industry now has more to offer, there is one aspect that continues to be ignored -- quality of disclosure.
By quality of disclosure, we are referring to the information shared by fund houses with investors. Whether it is disclosing information about the funds' investment proposition or their investment pattern, most fund houses are found wanting.
At Personalfn, we have always advocated the need for more comprehensive and superior disclosure by fund houses. This will help investors understand the various funds on offer and aid them in making informed investment decisions in their quest for achieving long-term investment goals. In light of the same, we put forth a wish list of five things that, in our view, fund houses must consider doing.
1. Investment objectives must be concrete and conclusive
Any investment objective that makes the investor wonder 'how is the fund going to manage my money' is a compromise. Far from being concrete and conclusive, most investment objectives only raise more questions than answer them. Imagine the investor's dilemma when every other equity fund in the country has an investment objective like -- 'To achieve capital appreciation from a portfolio that is invested predominantly in equity and equity related instruments' or 'To generate long-term growth of capital'. It's common to find tax-saving equity funds (equity-linked saving schemes == ELSS) have investment objectives like
'To deliver the benefit of investment in a portfolio of equity shares, while offering tax rebate on such investments made in the scheme under section 80C of the Income Tax act 1981
'
What do these unimaginative and vague investment objectives tell the investor about how the fund will manage his money? Nothing!
So the first point on our wish list for fund houses is that they must communicate to investors in no uncertain terms, as categorically as possible, what the fund's investment objective is and how it proposes to achieve the same.
2. Offer document/KIM must be comprehensive
This is an extension of the previous point. Just like investment objectives are often vague and inconclusive, the Offer Document and the Key Information Memorandum can be long and winding without revealing anything significant from a fund management perspective.
We believe fund houses have a responsibility towards the investor. To fulfill this responsibility, they must furnish him all the relevant information that he will need to make an informed investment decision. Unfortunately, although ODs have a lot of information, very little is really relevant for the investor. Apart from the legal and compliance related issues, what the investor would really like to see in the OD/KIM is:
i) What is the fund's investment mandate?
ii) How it will be managed in terms of investment style (growth, value, blend)?
iii) Whether it will invest top down or bottom up?
iv) What is its likely investment pattern (large caps, mid caps and their likely allocations)?
v) What is its asset allocation (whether it will take active cash calls)?
vi) Whether it will adopt the team-based or fund-manager-led investment approach?
vii) How the fund is distinct from comparable investments in the market?
viii) How it proposes to keep its expenses to the minimum?
So the second point in our wish list is that fund houses use the OD/KIM to communicate everything about the fund that the investor must know. Else a statement like 'mutual funds are subject to market risk; please read the offer document carefully before investing' has no meaning at all.
3. Say 'no' to disclaimers
At times fund houses do state explicitly how they will manage the money in terms of investment style and approach, investment pattern and asset allocation. But as if to say -they let on more than they intended, they qualify this with a disclaimer that the fund house can change some of the parameters as and when it deems fit.
To research analysts like us, it tells us that either the fund house is not sincere in its disclosure or it isn't confident that it will be able to manage the mutual fund within the parameters defined by it and hence the need to keep the door open for changing some of these parameters.
For the fund house, it can be a nuisance to have very precise investment mandates defined in the OD/KIM. Because every time they wish to make a change, it involves legal and compliance issues. To avoid this situation, they keep their investment mandates as open as possible or add disclaimers.
This is not only in theory, in the past we have seen mutual funds change their investment mandates seamlessly. In fact there is a fund house that swapped the investment mandates between two funds so that its large cap fund became a mid cap fund and the mid cap fund transformed into a large cap one (without any apparent reason). This was not surprising given that both these equity funds have investment objectives that read exactly the same, word for word.
By keeping the investment objectives of its mutual funds ambiguous the fund house no doubt reduced the compliance hassles for itself in the event of a change. However, imagine the plight of the investor who finds that his large cap fund has turned into a mid cap fund making his portfolio a lot riskier.
So the third point in our wish list is that fund houses abandon all disclaimers and make their investment mandates as precise as possible without leaving any door ajar to flout the mandates at a later stage.
4. Complete portfolio disclosure
For investors to 'interpret' the fund manager's investment strategy and ensure that he is abiding by the investment mandate, it is important that they access the fund's complete portfolio (and not just the top 10 stocks). This involves having access to all the portfolio constituents stocks, sectors and asset classes so that the investor can make an informed decision on whether the mutual fund is doing what it set out to do.
In the best interests of the investor, fund houses must declare the entire portfolio in a timely and consistent format for ease of comparison. All the stocks and sectors must be displayed in a manner to facilitate research and analysis so that investors can take an objective decision as to whether the fund manager is managing his money as promised.
Some points that fund houses must consider while declaring their portfolios:
a) A sector/theme-wise listing that combines all related sectors like auto and auto ancillaries for instance under a single head. Often fund houses tend to split these sectors so as to show they are well-diversified while in reality they are a lot concentrated.
b) A break up of stocks into large caps, mid caps and small caps; also definitions of the same should be provided. Fund houses have varying definitions of large caps and mid caps and investors are often confused whether a particular stock is classified by the fund house as large cap or mid cap.
c) If a particular fund has an uncharacteristically high allocation to a particular asset (like an equity fund with a 30% cash allocation) then fund houses must elaborate why it is not fully invested. Investors when they see a significant cash allocation in an equity fund are left guessing about the reasons for the same. It is for the fund house to take a cue and explain why the cash is there.
5. Complete disclosure of relevant ratios
In an extension of the previous point, fund houses must likewise provide updated ratios/statistics like Expense Ratios and Portfolio Turnover Ratios to help investors make more informed investment decisions. And these ratios must give a detailed explanation of how they were calculated given that different fund houses adopt various approaches (this is true at least in the case of the Portfolio Turnover Ratio).
In addition to the numbers, fund houses must have a note explaining deviations. For instance, if the Portfolio Turnover Ratio is unduly high, then fund houses must elaborate on the reasons for the same. In the past we have seen the Portfolio Turnover Ratio of a value fund higher than that of a growth fund from the same fund house. Most investors can judge for themselves that (at least within the same fund house) value funds must have a lower churn than growth funds.
When they see the opposite they are warned that something is amiss. By having a note alongside the ratios/numbers, fund houses can elaborate these finer points.
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