The markets and investor watchdog, Sebi, is planning to question fund houses on the underperformance of some of their schemes. Many mutual fund schemes have underperformed benchmarks for a period of time and the regulator is unhappy about it and is going to investigate the reasons for their underperformance.
The regulator’s intentions are noble but the fact is that it is not the regulator’s job to question a fund manager why his investment philosophy failed. That job is the job of the investor and if the investor does not like the returns he is getting from his investments he should withdraw his investments.
Investors in mutual fund schemes go through distributors (or investment advisors) who earn commissions for selling them the scheme. The distributor has to earn his commission by monitoring the performance of the fund and recommending to the investor whether he should continue to stay invested or leave the scheme. More recently, of course, distributors have been moping about commissions, and are more or less out of the picture.
However, we are on the question of underperformance, and the world over underperforming schemes lose assets and get downsized. Fidelity’s Magellan fund, once the largest single equity fund by assets in the world, which was once managed by the famous Peter Lynch, lost almost 90 percent of its assets over the last 10-plus years as the fund managers were not able to maintain the glory of the fund.
Fund managers underperform due to various reasons. Outdated investment philosophy and poor stock selection are some of the reasons for underperformance. The employer, the distributor and the investor should make sure that such fund managers do not stay and manage the fund.
Sebi’s role is to make sure that the fund has stuck to its objectives, there is no regulatory deviation and that the fund is not used as a garbage bin for better performing funds. A fund that has a stated objective of being invested in large-cap stocks and has instead weighted the portfolio towards mid- or small-cap stocks has deviated from its objectives. This is applicable to performing schemes as well and Sebi has to punish the offender whether the scheme is a performer or underperformer.
Sebi has to investigate if funds are sticking to the regulations. Overall security-wise weightages, derivative exposures, proper recording of transactions and correct dissemination of information have to be checked.
Sebi also has to check whether losses on stocks and derivatives are being passed on to underperforming schemes. Fund houses like to maintain the performance of schemes that have more assets under management and they are capable of taking short-term trading calls to improve the performance. If such trading calls go wrong the losses are palmed off to the schemes with lower assets under management.
The regulator is overworked and understaffed. Capital markets are extremely volatile and there are more and more cases of manipulation, insider trading and other such irregularities. Sebi’s record on bringing offenders to book is poor and one of the reasons is the sheer paperwork required for such acts. Sebi, by taking on the responsibility of micro managing funds, is only diluting its more important responsibilities.
Arjun Parthasarathy is the Editor of www.investorsareidiots.com, a web site for investors.