The Hindu Business Line : Investor fatigue and mutual funds

IN recent times, the Indian mutual fund industry has drawn lessons from the FMCG sector. The fund-houses, just like the corporate managers of FMCG companies, have introduced new products that are minor variants to the existing ones. Fund-houses attribute the introduction of such plans to "investor fatigue". That is, unit-holders are not inclined to invest more in the existing schemes. Since management fee is primarily a function of asset size, fund-houses have an incentive to increase investor inflows. It, therefore, pays to introduce minor-variant new products.

It appears that "investor fatigue" has some relation to the market conditions. Mutual funds tend to introduce more schemes when the stock market is declining than when it is moving up. Only two schemes were launched in September 2003 when the stock market was feverishly moving up. Contrast this with the six schemes that fund-houses launched in April 2004 when the stock market was down. The point is that the diversification benefit is not high when new products are minor variants of existing ones. Moreover, fund-houses incur additional expenses to market the new product, which further reduces the net asset value (NAV). Existing unit-holders' should realise that investing in such new funds may not be optimal.

Utility Vs Real value: A person can buy a consumable good that is only a marginal variant to the existing design and still feel satisfied. The reason is that a person derives utility value from the goods consumed. And utility value is a subjective outcome, which may have no relevance to the price paid. There is anything subjective about investments. Returns are based on a fund's performance. A unit-holder has to, therefore, be very careful in investing lest her portfolio suffers from concentration risk. This is the risk of investing a substantial proportion of one's wealth in single mutual fund or funds with similar portfolio composition.

Take Tata Mutual Fund's Income Fund and Income Plus Fund. The primary difference is that the Income Fund will invest not more than 40 per cent in unlisted bonds.

The diversification benefit for a unit-holder invested in both the funds may not be high. The minor-variant products are subtle for equity funds. The Sundaram Growth Fund, for instance, can invest in any stock. Its Leadership Fund, however, invests in companies that are leaders in their industry.

The portfolio manager's objective is to outperform the market. If that means investing in leaders, the Growth Fund's equity portfolio may be similar to the Leadership Fund. Unit-holders in both funds may, therefore, unknowingly run a concentration risk.

Problem areas: One reason for the spate of minor-variant products may be the illusion among investors that a new product is cheaper. The NAV of Templeton Mutual's Infotech Fund is Rs 18.75.

If Templeton were to launch another tech fund with minor variation in portfolio strategy, unit-holders of the Infotech Fund may, perhaps, invest in the new fund because its NAV is Rs 10 per unit.

The point that is missed is that the underlying portfolio for both funds is at the current market price. Because the existing fund bought the shares at a lower price, its NAV has risen along with the market.

Another reason may be the failure to differentiate between investment style and portfolio strategy. The former is the macro-level concept. A large-cap value fund is an investment style.

The value fund's portfolio strategy may be to invest in stocks that have a price-earnings multiple lower than that of the benchmark index.

The portfolio strategy is, hence, a micro-level concept. It is when portfolio strategies are used as investment styles to launch new funds that the problem of minor-variant products with similar portfolio structure arises.

Pareto Optimality: A central concept in game theory states that if a change in an outcome makes one person better off without making the other worse-off, there is scope for improvement.

By this definition, introducing minor-variant funds may not be Pareto efficient outcomes. The reason is that the unit-holders do not enjoy the diversification benefits that they will when the new products are based on different investment styles rather on portfolio strategies.

Besides, unit-holders incur additional charge on the NAV because of issue expenses. If the fund-houses are able to educate the unit-holders, the spate of minor-variant funds may not be the order of the day. Investor fatigue need not set in. The outcome may then be Pareto Optimal.

(Feedback can be sent to bvenky@thehindu.co.in)

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