Sucheta Dalal :Broking houses make investors go broke: The Kotak example
Sucheta Dalal

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Broking houses make investors go broke: The Kotak example  

May 13, 2010

 Portfolio Management Services or PMS schemes are often touted as the best way for wealthy investors to grow their wealth, but that is mostly in theory. Since their performance is never publicly reported, one has to go by anecdotal evidence of the prowess of portfolio managers. And the anecdotal evidence that Moneylife hears from time to time is pretty ugly.


We recently came across a disastrous story—a large number of PMS investors of Kotak Securities have suffered severe losses due to gross bungling by Kotak’s portfolio managers. PMS refers to services offered by finance companies, mainly broking companies, which manage the investor’s portfolio according to their skills (or luck). Unlike mutual funds (MFs), where the allocation patterns are often standard or structured, wealth managers invest according to what they feel best suits your portfolio. They also attempt to time their buying and selling.


While this may result in higher returns compared to MFs, it also carries a bigger risk and is usually used by high net-worth individuals (HNIs). Portfolio Management Services are meant for a minimum investment of Rs5 lakh to Rs10 lakh.

One customer who lost a significant amount of money approached Moneylife. After investing approximately Rs52 lakh in two Kotak Securities portfolios in January 2007, as on 31 March 2010, he had suffered a loss of approximately Rs15 lakh, or 30% of his total investment. In the same period, the fund’s benchmark indices, the BSE Mid-cap and BSE 200 were up by 15% and 30 %, respectively.


While we know that PMS is usually managed ineptly, mainly to generate brokerage income, an analysis of the performance of the two Kotak schemes, the Smart Investor Portfolio and the SIGMA Equity Portfolio shows shocking ineptitude. Month after month, these schemes have been making losses while the benchmark indices often posted significant gains. In fact, during periods where the markets were positive, these funds significantly underperformed their benchmarks.


A close inspection of the Smart Investor Portfolio (SIP) reveals that barring a brief period from October 2008 to March 2009, where it performed only marginally better the BSE Mid-cap—its benchmark index—the scheme underperformed its benchmark every single month from April 2007 to December 2009, a period of three years.

At times, the difference was scandalous. From April 2009 to December of the same year, while the benchmark shot up by 127%, Kotak’s scheme rose by only 37%—a staggering difference of 90%.


The SIGMA Equity Portfolio did even worse. From April to December of 2009 the benchmark, the BSE 200, posted 91.2% returns, but the scheme inched up by only 8.7%.


A pattern seems to emerge from the data. At the start of every major rally, the manager had most of the assets, at times even 85% in cash, only to sit out the bull run before realising that he might have made money by actually investing in the markets instead of watching from the sidelines. For example, in March 2009, at the start of a 120% bull run lasting months, the manager of the SIGMA Equity Portfolio had 77% of the funds in cash, increasing it to 95% over the next few months! This atrocious ability to neither buy the right stocks nor read the market correctly leaves one agape.


When the aggrieved investor complained to Kotak, the company stated, “It can be observed that most of the underperformance in portfolios is a result of high levels of cash, in the portfolio during Q2CY09 during the election time, maintained to protect portfolios in case of adverse election results. The decision to protect and de-risk the portfolio by remaining in high levels of cash during the June’09 quarter, in which the markets went up significantly, has reflected on the portfolio performance.” Sounds academic to us but utterly irresponsible to the investor who has lost lakhs.


Moneylife has copies of the communication between the investor and the company. When we approached Kotak Securities to understand what the portfolio manager was smoking, we received a similar bland, offhand reply. “In the April-June 2009 quarter, the Sensex went up by 49.49% and BSE Mid-cap by 71. 72%. Since we had taken a conscious call to adopt a defensive strategy of being under-invested, the performance of portfolio compared to benchmark started underperforming. As on 31 March 2009 the portfolio was not fully invested and had a major portion of the same in cash to be invested. We had communicated to our clients about the fact that the equity investment in these portfolios was less,” said the spokesperson. The company cites macroeconomic reasons behind its strategy of under-investing during March.


All this is a far cry from the sales literature of broking firms that entice you to invest in their PMS. “Portfolio Management from Kotak Securities comes as an answer for those who would like to grow exponentially on the crest of the stock market, with the backing of an expert,” reads the Kotak marketing pitch.


The only exponential growth seems to be in the losses that they have made. Kotak claims that “to understand the dynamics of various asset classes and investment options we use the best talent in the industry to come up with cutting-edge products.” This looks like pure snake oil. Investors will find it hard to understand how the “best talent in the industry” could make absurd judgement calls so as to lose a large chunk of capital in a period that has been hugely rewarding to investors.

In its sales brochure, Kotak states that their portfolio managers all have an average experience of over nine years in the equity markets and boasts of a research team with an average experience of five years. With such talent and experience, the Kotak team seems to be following two simple rules that take retail investors to ruin; One, “buy high and sell low”, and two, “chase market momentum too late”.


While making losses is perfectly natural in the equity markets, making such losses and under-performing the benchmark by such a huge margin consistently is pathetic. To add insult to injury, Kotak charges high fees for managing money under PMS. Indeed, the investor could have got a much higher return by investing in an index fund and wouldn’t have had to pay the high management fees charged by PMS. Incidentally, after some investors made some noise, Kotak has offered to refund the management fees. This could not be independently verified, however.


While the scheme was doing so badly, the investors were provided detailed quarterly reports, showing just how much money they had lost. Investors could see in minute details, the story of their sinking portfolio unfold.


In the quarterly reports sent to the customers, Kotak took great care to present the data in a detailed manner, with elaborate graphs, charts and tables, all trying to window dress the basic fact that the investor was losing money.


Kotak Securities is not the first company to have messed up PMS. Virtually every single broker is guilty of this. Some other broking companies do far worse. But nobody becomes wiser because there is no public disclosure of PMS performance.

Indeed, Moneylife is keen to compile the data about PMS and invites you write to us about the details of a scheme’s performance—whether good or bad. Email us at [email protected] — By Rudreshwar Malkani and Ravi Samalad

-- Sucheta Dalal