The Hindu Business Line : A fund of disclosure, yet inadequate

DISCLOSURE standards adopted by mutual funds in India are probably the best in the world. Importantly, SEBI and the Association of Mutual Funds of India have come together to orchestrate the changes in the reporting standards that have helped investors. Yet, investors still face problems.

Some important statistics on mutual fund performance are not reported and, even if they are, there is a lack of standardisation in the way the numbers are calculated.

The most important issue in mutual fund performance reporting, however, relates to the choice and suitability of benchmarks. Often, performance is compared to indices that are not appropriate standards.

In the case of the insurance sector, there is growing realisation that it should be treated on a par with mutual funds.

The service offered by insurance in investment management is not very different from that offered by mutual funds.

The disclosure standards adopted by insurance companies are, however, several notches lower than those of mutual fund houses.

Fund-house disclosures: The entry of Fidelity into the asset management business in India stirred up much interest among investors and competitors alike. That the fund managed to garner Rs 1,500 crore reflects the expectations from Fidelity.

But the fund house has also sparked a debate on disclosures.

First, it took its time to disclose its portfolio for the period ended June 2005, and when it did revealed only the top ten holdings.

This is in stark contrast to the practice of most other mutual funds, which disclose their portfolios fully every month. Fidelity, it appears, will make complete disclosures only every half-year.

One can argue that complete disclosure every month would neither add to fund costs nor will it detract from fund performance.

However, Fidelity's right to disclose portfolios at shorter intervals will have to be respected.

It also highlights the fact that month-end portfolios are irrelevant in investment decision-making, as the composition could change at a short notice.

What matters is the investor faith in the investment manager. And that is driven by a different set of variables. Investors need, at least every quarter, standardised disclosures on the following:

The size of assets under management

The invested position — that is, cash as a proportion of net assets

The portfolio turnover

The expense ratios

The correlation in net asset value movements with a suitable benchmark index over varying periods

The decomposition of returns in terms of value added by the fund manager and value attributable to the risk taken over varying periods

The number of months in which fund performance surpassed that of the benchmark index

The performance of the systematic investment plan for the fund and the benchmark index over varying periods

The average P/E multiple, the Average Dividend Yield and the Average Beta for the portfolio at the end of the period

The absolute return performance of the fund over varying periods and under different fund managers

More than the portfolio, these statistics would clearly reflect the manager's performance and help investors decide if they can trust his skills.

Appropriate benchmark: Equally important is the choice of benchmark. Many diversified equity funds have the Nifty or Sensex as their benchmark. They, however, invest in mid- and small-cap stocks.

In an average diversified equity fund at least 10-30 per cent is invested in mid-cap stocks. The Nifty can then no longer be the benchmark.

Similarly, many mid-cap funds use Nifty Junior as their benchmark. They, however, invest in stocks with a market capitalisation smaller than the smallest market capitalisation stock in the Nifty Junior index.

If fund houses feel that a publicly available benchmark is not suitable, they should create an appropriate index.

For instance, the managers of Templeton India Growth, UTI Master Value, Tata Equity P/E and a number of dividend yield schemes could get together to create a value stock index. Similarly, growth funds could get together and create a growth stock index.

Creation and maintenance of such appropriate indices is not costly and would only add to the fund manager's investor friendliness. Besides, without such appropriate benchmarks, evaluation of fund performance will never be complete.