Sucheta Dalal :Fund prospectuses: Too much legalese too little substance-II
Sucheta Dalal

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Fund prospectuses: Too much legalese, too little substance-II  

March 12, 2010

A few months ago, Birla Sun Life launched a T-20 Fund. Taking advantage of the popularity of the shortest format of international cricket and its glamorous affair with Bollywood, the Fund is nothing but a fancy idea in the garb of innovation.


The T-20 Fund would have in its portfolio a selection of the top 20 growth companies. Have concentrated portfolios worked in the past? Will they work now, and why? Has the fund manager specialised in concentrated bets in the past? Does not a concentrated approach go against the main mantra fund management—diversification? The prospectus does not answer any of these questions.


Birla Sun Life is not alone. The JM Agri & Infrastructure Fund was another bizarre concept. How can one combine agriculture and infrastructure? The Fund’s bet was that successive governments have been making huge outlays for social infrastructure and the development of the rural sector and every Union Budget emphasises the importance of the agriculture and infrastructure sectors. How would the Fund pick stocks? There were no clues in the prospectus. All that the JM Agri & Infrastructure Fund’s prospectus said is that it has a research set-up that would identify investment opportunities through continuous monitoring of sectors and companies.


Is such meagre disclosure in prospectuses fair? Should the regulator, Securities and Exchange Board of India (SEBI) not ask many more questions before allowing fund companies to raise money? Why should companies wanting to raise money from Initial Public Offerings (IPOs) put through such extensive disclosures including their track record and not mutual funds? Fund after fund has been trying to launch schemes that look more like marketing gimmicks than a product of well thought out portfolio strategy. Why should the fund management companies look like competing with soap marketers and why should the regulator, SEBI, be an ally in the process?


Fund management is a business to gather more and more of assets. Fund companies make a regular income as a percentage of assets they hold. The higher the asset base, the higher their income. Quite clearly, fund companies are fully incentivised to raise more and more money. Maybe there is nothing wrong with this, as long as they can put the money to use efficiently.


However, for some reason, fund companies think that they cannot acquire more assets by selling existing funds. Hence, the need to launch new funds. Now, an equity fund, like a product like shampoo, can offer a limited variation in terms of its core features. To sell more and more of shampoo, personal product companies come up with different fragrances, colours and celebrity endorsements. Funds cannot use celebrities but they do compete with shampoo companies in their bizarre ideas, without being accountable.


New, strange ideas coming from funds can be bizarre like T-20 or it could simply be a portfolio approach that is illogical or not supported by empirical evidence. Take for instance, Tata Consumption Opportunities Fund launched late last year. The Fund, an open-ended scheme, had a mandate to invest in companies into production, distribution or trading of goods and services meant for mass consumption. The premise is that a period of rising gross domestic product (GDP) growth and consumption will lead to rising stock prices of consumer goods companies. Sounds logical. Except, it isn’t.


First, it is wrong to assume that there is a definite correlation between these GDP growth numbers and rising stock prices. Between 1994 and 2003, GDP grew every year. Prices of many stocks were stagnant or on the decline. Second, it is assumed that the expansion in organised retail across the country would benefit the consumer goods industry. This is not necessarily true. Whether consumers buy their shampoo from a small grocery or a hypermarket makes little difference to consumer goods companies.


In early 2008, Benchmark, which pioneered the idea of exchange-traded funds in India, filed a prospectus to launch Citigroup’s method to offer Value and Momentum Quant Fund that will invest in stocks that offer the best combination of value and momentum. Does this idea make sense to the average retail investor who has been exhorted for years to go to mutual funds?


One other fund house announced the launch of something called a 50-50. No, it is not some kind of self-deprecating humour by a fund house referring to the fact that the outcome of their stock-picking is often random (50-50 probability). The name comes from a portfolio design under which 50% of the money will be invested in stocks selected across the market and the other 50% in stocks of just one chosen sector! It surely came from the head of an excessively creative marketing hotshot, who was possibly selling biscuits in his previous job and will probably sell insurance in the next. It makes zero sense.


Now, a fund can dare to launch such a scheme when it knows that SEBI will merely rubber-stamp ideas even if they are ill-researched, clever concoctions, which will only fatten the corpus of the fund houses at the cost of the investors. Such schemes usually mushroom during a solid bull run, when investors easily fall prey to fancy advertisements flashing unique investment opportunities. There is another issue and that is beyond prospectuses. Often fund companies deviate a long way from their prospectuses, labelling commercial vehicles as infrastructure stocks, power companies as banking stocks and media companies as technology stocks.


But there is a price to pay for the liberties fund companies take and the laissez faire approach of SEBI. The low penetration of mutual funds and their poor risk-adjusted performance against benchmarks is directly linked to the ease with which they can bring in new fund offers (NFOs) and do performance chasing. If SEBI had demanded rigour in NFOs and asked funds to stick to their mandates, investors’ confidence and participation would have been at a different level.


It is time SEBI introduced a proper, functioning screening model to identify those fund offers that seem dubious or far-fetched. The only time to do this is when the draft offer documents of these schemes land on SEBI’s doorstep for approval. This has to be followed by quarterly monitoring of whether the funds are actually following the mandates under which they had raised money — Debashis Basu


-- Sucheta Dalal