Mutual Funds

Should fund managers take a pay cut?

AARATI KRISHNAN | Updated on December 24, 2011

The fund manager's job is to deliver returns that beat the chosen benchmark and if he fails to, the investor should cash out.

“If my equity fund has lost money over the past year, why should I pay the fund manager his fee?”

Investors often ask this question when stock markets fall, as this year.

The answer lies in why we invest in a mutual fund. If I invest in an equity fund, I do so because I think stock markets, over a five-year-plus period, will deliver a healthy inflation-beating return of 15 per cent or more.

Now, equities by their very nature do not deliver that return in a methodical manner. Some years such as 2009 will be exceptionally good, when equity funds produced an 80-per cent return. Others, such as 2011, will see a fall, cutting into investors' capital.

Flouting the mandate

To expect an equity fund to somehow preserve capital when stocks in the market have fallen like nine pins is unrealistic. The only way an equity fund manager could have managed a positive return in 2011 was by knowing in advance the markets would fall and then moving the entire portfolio into cash or debt instruments or by investing the entire portfolio in sectors such as FMCG or pharma, which gained this year.

But even if a fund manager did miraculously second-guess the markets, moving the entire portfolio into cash or debt instruments would be a serious violation of the mandate given to him.

And what if his guess proves wrong and stock prices take off like a rocket?

Indeed that is what happened in March 2009, when many equity funds sat on cash piles and missed the best part of the bull market.

Putting the entire portfolio into a handful of FMCG or pharma stocks, too, carries plenty of risk. Again, this is what fund managers actually did at the fag-end of the 2000 tech stock bubble. When the crash came, the concentrated portfolios took a battering from which they never recovered.

Allocate right

A mutual fund does not promise any absolute returns. It merely promises to do better than the chosen asset class, be it equity or debt.

As a retail investor, you can prevent the wild swings of equity funds from hurting your wealth by selecting the right funds. If you are risk averse, stay clear of equity funds altogether.

If you can only take some risk, invest in 80:20 funds such as Monthly Income Plans that have a sizeable debt portion that will curtail NAV fall.

Accountable, yes

This is not to say that mutual funds are not accountable for their performance. Not by a long chalk. The fund manager's job is to deliver returns that beat the chosen benchmark and if he fails to, the investor should cash out. For example, given trends in interest rates, a short-term debt fund that didn't manage a 8 per cent return in 2011 is probably not worth holding; nor is an equity fund that saw its NAV slide by 30 per cent plus, while the Nifty lost 23.5 per cent. Nine out of ten equity funds, however, did better than the Nifty in 2011.

Pay cut

Despite all this, you will probably feel better knowing that managers of equity funds are likely to have taken a cut in their fee this year. In India, mutual funds earn a management fee that is capped at 1.25 per cent of the assets managed. That makes for an automatic ‘variable pay' structure.

Now, assets under management for equity funds are computed by multiplying the number of units managed with NAV per unit. NAVs fell by 23 per cent in the last one year and fresh units sales also dried up because of falling NAVs. A ballpark calculation applied to the equity assets disclosed shows that fund management fees for the industry as a whole may have fallen by 20 per cent. That's the pay cut equity fund managers took.

Published on December 24, 2011

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