• Investment World
• eWorld
• Catalyst
• Mentor
• Life
• Canvas
• Praxis
• Urban Pulse
• Brand Quest

Aarati Krishnan

THE patterns in fund flows into equity mutual funds over the past four years reinforce the view that investors in equity mutual funds are guilty of the cardinal error of buying high and selling low. These trends could also have certain implications for fund performance.

High cost portfolios: A back-of-the-envelope calculation shows that around Rs 27,600 crore, or 61 per cent of total inflows notched up by equity funds over the past four years, were invested at Sensex levels of over 4000 points.

This suggests that for a high proportion of investors, the initial cost of acquisition for their fund holdings is likely to be quite high. This certainly raises the bar for equity fund managers. The return numbers from equity mutual funds look spectacular when measured from levels in September 2001 or September 2002, when the markets were at their nadir.

But the pattern of fund flows definitely suggests that these could be just "paper" returns for the majority of investors in equity funds, as many of them would actually have entered the fund either midway through or in the late stages of a rally.

Churn may cause upheavals: Left to his own devices, a fund manager may like to build up the major portion of his portfolio when markets are in "idle" mode and stay put, or book profits, when they are in high gear. But the considerable upheavals caused by inflows and outflows during a bull market may upset these calculations.

Computations show that the "churn rates" (sales and redemptions, as a proportion of net assets) pick up sharply during bull phases. For instance, in September 2003, equity funds attracted gross inflows amounting to 15 per cent of the assets under management, and gross outflows amounting to 12 per cent.

The numbers for the preceding two months were no different. The net effect of these may be small, for the industry as a whole. But inflows and outflows may not be evenly matched within each equity fund.

When significant proportions of assets enter or leave the fund, they are bound to force the fund manager to trade more actively on his portfolio, even if he deems it the wrong time to do so.

If a fund faces a significant one-way flow, it would force the manager to either liquidate or add significantly to his portfolio amid volatile market conditions. This is bound to add to the risk profile of equity funds as a class.

Undermining long-term performance: Large-scale inflows into equity funds at the height of a bull market may end up undermining returns for the investors who entered at more moderate market levels.

For instance, funds with a good track record, such as Franklin India Bluechip Fund, Franklin Prima Fund, HDFC Equity Fund and HDFC Top 200 Fund, received substantial fresh inflows over the past six months, adding 25-50 per cent to their asset base by way of new inflows alone.

Managers of these funds may have no choice but to invest a substantial portion of their incremental assets in a market where valuations appear stretched, especially for many large-cap stocks. Investors in the funds, therefore, need to keep closer track of performance now.

The additions made to the portfolio under present market conditions would add to the fund's risk profile and could prove a drag on performance, especially if the recent rally runs out of steam.

Article E-Mail :: Comment :: Syndication

Stories in this Section
Tyres: Punctured by high input costs

Copyright © 2003, The Hindu Business Line. Republication or redissemination of the contents of this screen are expressly prohibited without the written consent of The Hindu Business Line