Mutual Funds

Four signs of friendly funds

AARATI KRISHNAN | Updated on October 27, 2012

With effect from October 1, many large fund houses have hiked the expenses that they charge to their equity schemes by 0.25 percentage points, taking advantage of SEBI’s recent relaxation in the expense limit. But Quantum Mutual Fund has chosen not to take this hike.

Economising on charges

Its flagship Quantum Long Term Equity Fund as well as Quantum Tax Saver will continue to have expense ratios of 1.25 per cent of net assets, while other funds in Quantum’s fold will charge even less. Now, given that Quantum’s equity funds are consistent performers and that expense ratios in equity fund space can now go up to 2.5 per cent a year, this is certainly an investor-friendly move. The fund house, especially given its relatively small size, could have certainly increased its expense ratio and pocketed a tidy profit for itself. Instead, it has chosen to forego the fee and leave more on the table for investors.

A fund house keeping its costs well below statutory limit is certainly one sign that it is investor-friendly. But what are the other such signs?

Limits on fund size

A fund voluntarily shuttering its schemes to fresh inflows is another. In the mutual fund industry, size begets profits as asset management fees are linked directly to the size of a fund. But in some product categories, a very large size can impede performance and adversely impact investor returns. For instance, a small-cap fund of gigantic proportions may find it difficult to build or liquidate its positions without impacting the stock price.

Some fund houses, therefore, choose to limit inflows into certain funds, in order to sustain good performance. IDFC Premier Equity Fund, for instance, invests in stocks from emerging businesses early in their lifecycle. As such opportunities may not be always available, this Rs 3,000 crore fund, despite being open end, allows fresh inflows only at specific time intervals. Given that this fund is sought-after for its good track record, this is an investor-friendly move that protects the interests of incumbent investors.

Quitting when the time is right

Given that fund houses often go all out to launch sector funds when the theme is sizzling hot, they must also signal to investors when the idea runs cold. A theme fund should thus be wound up or merged if a fund house feels it cannot sustain its past returns. But as that usually means lost assets, fund houses usually prefer not to take any action.

Some fund houses have been an exception to this. FMCG and pharma stocks have been the darlings of the market for nearly three years now, outpacing broad market indices by a huge margin. Needless to say, funds playing on these sectors have been chart-toppers, sporting annualised five-year returns of 31 and 19 per cent even as the Nifty only scrounged together 5 per cent.

Yet, in August 2011, Franklin Templeton Mutual Fund decided to merge its Franklin FMCG and Pharma funds into Franklin India Prima Plus, a diversified equity scheme. A signal that it is best to cash out of these themes while the going is good?

Discouraging churn

In an open end structure, frequent purchases and sales of units by large corporate investors can adversely impact returns for the remaining unit-holders. Such churn forces the manager to park more money in low-return earning avenues.

Large redemptions can also force a fund to sell securities at sub-optimal prices. Debt funds are particularly susceptible to high churn, as they tend to be parking grounds for corporate treasuries and other large investors. In this backdrop, a debt fund which discourages short-termism through exit loads is certainly more investor friendly than one which allows smart money to move in and out at whim. Birla Sun Life’s Medium Term Plan, for instance, imposes an exit load on any investor who redeems within two years of investing. The exit load can be as high as 2.5 per cent in the first six months.

With SEBI recently requiring fund houses to treat exit load receipts as part of the NAV of each scheme, investors who stay on in such funds will gain at the cost of those who beat an early retreat. We need to see how many debt funds impose an exit load after this change. Those who do are certainly small-investor friendly.

> Aarati.k@thehindu.co.in

Published on October 27, 2012

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