When funds alter their positioning…

When funds alter their positioning…Consistency is an important virtue while managing finances. This holds true not only for investors, but also fund houses that are responsible for managing investors’ monies. Any slip-up on the same could spell disaster for investors. Sadly, lack of consistency is a prevalent phenomenon in the mutual fund industry. And quite shockingly, it is the fund’s positioning, which is found to be inconsistent.

Every fund has a defined investment mandate/proposition, which is conveyed in its positioning. It informs investors, what the fund has set out to achieve and how it intends to do the same i.e. where the fund will invest its money. It would be fair to state that the fund’s positioning defines what it offers investors.

Expectedly, investors make their investment decision based on the fund’s positioning. It helps them decide whether or not a particular fund fits into their portfolio. For instance, a fund that professes to be an aggressively managed mid cap fund would qualify as a high risk-high return investment proposition. Hence, investors who have an appetite for high risk investments would typically consider adding the fund in their portfolios.

But the trouble begins when fund houses unilaterally (i.e. on their own and without informing investors) decide to alter the positioning of a fund, thus leaving investors in a lurch. For example, a fund, which has been positioned as a large cap fund, is converted into a mid cap one or vice-versa. It must be noted here that not all fund houses act in an arbitrary manner while altering the positioning of their funds; some fund houses do inform investors and seek necessary approval from the regulator. Our grouse is against fund houses, which fail to do so and act as per their whims and fancies.

For example, recently we came across a long-term floating rate debt fund that has been repositioned as a fund that can maintain flexible maturities. At present, the fund maintains a maturity profile, which is comparable to that of a liquid fund or a liquid plus fund (these funds have slightly longer maturities than liquid funds). While a long-term debt fund would typically be suited for investors that have an investment horizon of a year or thereabouts, liquid and liquid plus funds are apt investment avenues for parking short-term surplus funds i.e. investors would typically have an investment horizon of less than 3 months.

Now why would fund houses incorporate such a radical change in the fund’s positioning? Perhaps because the investment (read interest rate) scenario is unsuitable for a long-term debt investment. But that isn’t a good enough reason to change the fund’s positioning. The same would have been justified if the fund’s positioning in the first place explicitly stated that the fund can change its character in line with market conditions. Introducing a new positioning at a later stage isn’t justified.

We have learnt that the reason for the aforementioned transformation is lot more sinister than meets the eye. Union Budget 2006-07 introduced a penal tax structure on dividends declared by liquid funds vis-à-vis other debt funds. This made investments in liquid funds unattractive for corporates and other investors. The importance of corporates’ contribution to a fund house’s assets under management is a well-known fact. Fund houses decided to bail out their corporate investors by repositioning long-term debt funds as liquid plus funds. Effectively, while prima facie the fund would seem like a long-term debt fund, it would be managed like a liquid plus fund. Hence corporates have the option of investing in a liquid plus fund and yet enjoy the benefits of a liberal tax structure i.e. a long-term debt fund.

Fund houses may try to justify their actions under the pretext of protecting investors’ interests. We have a question, what about the interests of investors who got invested in these funds, assuming (and rightly so) that they were getting invested in a long-term debt fund? Let’s not forget that the change in positioning was an “off-the-record” and unilateral event. Hence the aforementioned investors have their monies being managed in a manner, which is different from the original stated one.

Fund houses which tend to be rather trigger-happy while launching new fund offers (NFOs) of the equity variety, adopt a different stance when debt offerings are concerned. Instead of altering an existing debt fund’s investment, fund houses could easily launch an NFO. But then mobilising monies in a debt NFO is easier said than done; hence, the easy route – alter an existing fund.

At Personalfn, we strongly believe that fund houses, which wish to change the positioning of their funds should do so, but only after all adequate steps to protect investors’ interests have been taken. For example:

• To begin with, investors’ woes can be largely taken care of if funds have a watertight positioning that is explicitly communicated. Ideally, the investment objective should be used to communicate what the fund can offer investors. This in turn means that ambiguous investment objectives like “the fund aims to generate capital appreciation” should be done away with. In such a situation, any deviation from a clearly laid out investment objective will be easy to detect.

• Fund houses should be permitted to alter the positioning of their fund only by taking a legal route i.e. necessary approvals need to be obtained from the regulator. Existing investors who don’t wish to stay invested in the fund in its new avatar should be given the option to exit without bearing an exit load.

• The new positioning must be communicated to the public at large through disclosures in the offer document and the fact sheet. This will ensure that prospective investors are unambiguously aware of what the fund has to offer. Also the fact that the fund has changed its positioning must be explicitly mentioned in all communication.

• Finally, fund houses must be prohibited from using the fund’s previous performance history. For example if a fund has been a mid cap fund for 4 years and then been converted into a large cap fund for a 1-Yr period, then it should be permitted to show only a 1-Yr track record. Displaying a 5-Yr track record would be misleading for investors.

• Investors on their part would do well to conduct a thorough evaluation of any fund before getting invested in it. The investment advisor has an important role to play in helping the investor ascertain if the fund has been honest to its stated positioning.

• Every investor has the right to expect that his investment will continue to be managed in a predetermined manner, going forward as well, irrespective of how markets are placed or changes in the investment scenario. We urge the regulator to ensure that investors'interests are protected on all these counts.