The Hindu Business Line : Dealing with fund manager churn

WITH India emerging as the hot new destination for global investors, the stock market is soaring. Investors have enjoyed a long, uninterrupted spell of breathtaking returns from their equity funds. But a buzzing stock market has also had an unexpected offshoot; it has set off a game of musical chairs within the funds management community. Fund management teams of mutual funds are witnessing much higher churn in their ranks than before.

Over the past two years, Kotak Mutual Fund, SBI Mutual Fund, PruICICI Mutual Fund and Birla Mutual Fund have lost two or more senior members from their management team. It is natural for investors to wonder if the fund's performance will be affected by the exit and entry of key managers. We analysed the phenomenon over the past five years and spoke to a few fund CEOs for their perspective, before addressing common investor worries.

Behind the churn

The attraction of the "India story" has had a veritable flood of global investors — foreign funds, pension funds, private equity funds and hedge funds — crowding the stock market. Domestic brokerages are also thriving; banks that have not yet made a foray into this business are now anxious to get their mutual fund arms up and running.

With so many investors looking to grab a piece of the action as quickly as possible, the demand for experienced fund managers has shot up over the past couple of years. Managers who have put in 5-8 years in the mutual fund industry appear to be sought-after recruits, given their disciplined approach to investing, familiarity with Indian stocks and their impressive record in trouncing the indices.

With everybody looking for experienced hands, the supply of fund management talent is far short of the demand. While fund manager exits have been happening over the past ten years, the churn has increased over the past two years.

No exodus, though

Despite the churn, retail investors need not worry about a dearth of talented managers to look after their money. There hasn't been a one-way flow from mutual funds to private equity or hedge funds. A few fund managers (such as Sandip Sabharwal of SBI, Rushabh Sheth of Kotak) have left the fund industry to move to private equity funds.

But an equal number have stayed within the industry (Paras Adenwala of Birla Sun Life, Nitin Jain of SBI, Deven Sangoi of Birla, Vinay Kulkarni of UTI), only leaving their respective funds to join rivals. A few managers have moved to new AMCs that have set up shop. Some of the churn is also because of established fund houses trying to fill in the gaps in their teams left by exits.

The compensation angle

Fund CEOs hotly deny any suggestion that their compensation is not the best in the industry. For one, fund manager compensation has been steadily rising over the past two years and funds are now willing to pay fancy salaries and performance-linked bonuses to retain talent. They can now afford to do this as well.

A sharp growth in asset size and a rising proportion of equity assets under management has made the established asset management companies very profitable (equity funds, with their higher entry loads and management fees, bring in much more money for every rupee invested than debt assets).

The fund management business is also very scalable; the same team that manages a Rs 100-crore fund can easily manage a Rs 1000-crore fund. What is more, given the small teams, employee costs make up a small proportion of the overall cost structure for an asset management company. Fund houses with large teams such as UTI Mutual Fund and HDFC Mutual Fund shelled out just 18-19 per cent of their management fee for the year, as employee cost, leaving considerable room for ramp-up in fund manager pay.

Handling the churn

Fund-houses too are trying to immunise investors from the effects of churn; by expanding their teams, sharing responsibility between managers and stressing on "process-driven" research. Fund houses such as PruICICI, SBI and Birla have added senior fund managers through lateral recruitments.

Kotak Mutual has drawn extensively from the research teams of its broking and private client businesses to fill gaps in the mutual fund. UTI Mutual Fund has promoted senior research analysts to vacant fund management posts. Fund houses are retaining larger management teams by making campus recruitments and grooming analysts to take on a fund manager's mantle.

UTI, Birla Sun Life and Franklin Templeton have instituted a system of shared fund management, under which two managers are assigned responsibility for every fund.

This creates a "backup" and ensures continuity of style in the event of one manager's exit. Fund houses are also reducing the discretion that managers have in managing a portfolio by laying down "processes" or "templates" for each product. Typically, this is done by short-listing an investible universe of stocks for each fund, laying down stock-specific and sector limits. Chief Investment Officers are also defining the type of stocks that can enter each fund more precisely, using quantitative filters.

Impact on performance

Empirical evidence from fund manager exits is not conclusive; some exits have had an impact on fund performance while others have not.

Samir Arora's exit from Alliance Capital in mid-2003 was followed by a run on assets and a steady deterioration in the performance of Alliance's equity funds. However, this was partially attributable to uncertainty about the continuation of the sponsors in India.

Birla Advantage Fund, Kotak K-30 and PruICICI Growth Fund, which have seen their fund managers change twice or more over their tenure, have not delivered the kind of consistent performance that their peers have managed. However, funds such as HDFC Equity and Taxsaver, Magnum Contra and PruICICI Tax Plan have convincingly beaten their peer groups despite witnessing mid-course changes in fund managers.

Continuity of a particular investment style or strategy seems to play a greater role in ensuring consistent performance from a fund, than the identity of its manager. If the gap left by a manager is filled by an equally experienced one from the same team, the impact on performance may be minimal.

You also need to worry less about a fund manager's exit if you intend to hold a fund's units for a long period of, say, 5-10 years. Over a holding period of five years or more, even funds that have slipped up because of manager changes have often pulled up their performance, at least to the peer group average.

Info on managers

Funds usually notify investors of changes to their fund management team through advertisements in the business newspapers. But it may be difficult to lay your hands on the relevant notification when you want to invest in a fund. In that case, look for the latest offer document filed by the fund for a New Fund Offering and check the section outlining "key personnel". This will outline the current fund management team and the responsibilities of individual managers.

The published notifications about fund manager changes will also be available in the addenda to the offer document, on individual fund house Web sites.

Checklist for investors

INVESTORS would naturally want to know what they should do when the fund they have invested in is faced with a churn at the top. Here are some dos and dont's:

If you have selected the equity fund because of its consistent record over five years or more, don't exit in a hurry.

Check the profile of the new manager to see if his experience in equity research or fund management extends over a complete market cycle (in India, this may mean 7-8 years of experience). Stay with the fund if he fits this profile.

Track fund performance more closely over the next six months to a year. Exit if you find it lagging its benchmark at any time on one-year returns.

If this is the only fund you own, it is best to diversify into two other diversified funds with a good record and with a different manager. This will reduce the vulnerability of your investment returns to changes in management style, after the fund manager's exit.

If you learn of several changes in a fund house's investment team, switch to the flagship diversified fund managed by the house. If talent is in short supply, a fund house would always like to assign its best talent to its flagship fund.

Some types of funds rely more on an individual manager's skills than others. Sector funds are usually managed by a person with a flair for selecting stocks in that sector. If he quits, his replacement may take time to acquire a similar depth of understanding about the sector.

Theme funds, such as a small cap fund or a "global opportunities fund" may also call for specialised individual skills, not easily replaced at short notice.

Fund manager changes in such cases have to be taken more seriously than those for plain-vanilla funds, and it may be prudent to switch to a diversified equity fund.

Funds with clearly-defined objectives such as a dividend yield fund or a top 100 or 200 fund are less likely to report sharp variations in performance because of fund manager changes.

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