Sucheta Dalal :Mutual Funds: Look before you leap
Sucheta Dalal

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Mutual Funds: Look before you leap  

October 13, 2003

Where mutual funds are concerned, its best to look before you leap.  Although several funds have announced excellent returns in thier equity schemes, the bull run is getting too volatile to for complacency. This article appeared in Divvya Bhaskar (in Gujarati) on October 13,2003.


Look before you leap


By Sucheta Dalal


We are clearly in the middle of the biggest bull run in decades and the booming capital market is again looking to ensnare its old friend, the clueless retail investor. As always, small investors, with their sketchy knowledge about stocks and shares are the last to enter, lured by the prospect of mega money merely by writing out a cheque to an open-ended equity fund.

There are other attractive factors as well. For instance, Business Standard reports that many mutual funds have announced fantastic returns for the six months period since March end. As many as 35 funds have delivered returns between 53 to 102 per cent; while Tata Mutual Fund’s Equity Opportunities Fund and Franklin Prima Fund have returns of 102.7 and 101.4 per cent respectively followed by Reliance Mutual Fund’s Growth scheme (98.76%), Sundaram Select Mid Cap (93 %) and Tata Pure Equity (92 %)

Such announcements have led to the inevitable rush for MF investments, encouraged by tiny investment advisory shops sprinkled across many Indian metros.

Thanks to their pushing, funds like Templeton, Prudential ICICI and HDFC Mutual Fund had attracted between Rs 100 to 300 crore each in September.

The good news is that retail investors are not being very indiscriminate as yet. The growth in mutual fund assets, although positive, is not yet a wild rush.  Does this have anything to do with the general worldwide distrust about mutual fund regulations spawned by U.S.investigations? Has Eliot Spitzer’s (New York Attorney General) indictment of the biggest mutual funds in the world scared Indian investors too? Hopefully the answer is a big yes.

Many of the Funds investigated by Spitzer have operations in India and probably follow similar trading practices. Spitzer has revealed that apart from problems like blatantly fake research reports, connivance with companies and plain incompetence that was exposed by the US corporate scandals a year ago, mutual funds have employed other tricks to cheat their investors.

Fund managers permitted what are called ‘late trades’ to allow certain large investors to log in illegal trades after closing hours although it hurt the Fund and its small investors. So far, Spitzer has extracted confessions from such big names as Alliance Capital, Prudential Securities (fired 12 employees for late trades), Merrill Lynch (sacked three employees), J.P.Morgan Chase, Bank of America, Janus Fund and Bank One. Many of the Funds, caught in the act of stealing investors by Eliot Spitzer are now offering to make good the losses suffered by their investors.

But is it good enough?

It reminds us of the Bombay Stock Exchange’s infamous decision in 1998 to open the trading system after midnight, to allow a chosen few investors, to log in illegal trades at off-market prices during Harshad Mehta’s comeback attempt in 1998. The BSE move was more reprehensible, because here was a regulator, misusing and manipulating the trading machinery to avoid an embarrassing default that would expose its poor supervision and collusion with the scamster. 

The American late-trades however were a direct assault on the trust reposed in the Funds by their investors. In an interview with the Washington Post Eliot Spitzer said, “Late trading is over the line, criminal and unambiguous. It is a direct transfer of money from long-term shareholders of a mutual fund to those who are being given an illegal advantage”.

Spitzer’s actions have thrown the American mutual fund industry into turmoil.  Funds are sacking employees, disgorging illegal gains and the industry is getting together to frame new rules to disallow late trades.

Now cut to India and you find that the mutual fund industry has not even reached the size where this form of cheating is relevant. Most investors are clueless whether similar practices could cheat them out of legitimate earnings. At the same time, reports of front running by Fund managers are common enough to force SEBI Chairman G.N.Bajpai to warn the industry of punitive action. 

Add to this the fact that in over ten years of existence we have no bit stars among Fund Managers. Ironically, Alliance Capital’s Samir Arora was probably the best-known fund manager in the country, and he is under a huge regulatory cloud today. Even excluding the preposterous double debacle of Unit Trust of India (UTI), the industry does not have a long enough track record, even to decide whether mutual funds are indeed a good investment vehicle for small investors.  And as studies in the U.S. have shown, the past is no indicator of the future returns.

Investors must bear all this is mind – before rushing into to mutual funds at this late stage in the bull run, otherwise they will end up being the fall guys who give large operators and hedge funds a profitable exit. And again, they will again end up holding depreciated stocks.

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-- Sucheta Dalal