Mutual Fund tip: What to do when your fund gets taken over by another

Let's take the Fidelity-L&T deal. Fidelity India, with a seven-year history, had 70 per cent assets in equity. In the past three years, four of its five equity funds were among the top 10 in their categories. This means it had a strong equity team.

One concern over the deal is that L&T will not retain Fidelity's equity fund management team. But N Sivaraman, president & wholetime director, L&T Finance Holding, is not worried. He says the two fund houses have the same investment philosophy of bottom-up stock-picking based on research.

"We have significant bandwidth in the equity team comprising nine members which will ensure that the integration is smooth and investors continue to enjoy the same high-quality experience," he says.

Further, Fidelity's equity team will put in place all investment processes during the transition period.

But, a lot will depend on how the fund house shapes up in its entirety considering that L&T Finance has limited experience in the fund management industry.

In fact, L&T Mutual Fund came into existence when it acquired DBS Cholamandalam in 2010; since then, it has been predominantly a debt player with 95 per cent of its Rs 4,000 crore assets in the fixed-income category.

"It may be worth observing the performance of the funds vis-a-vis benchmarks for three quarters before taking a decision to buy or sell," says Gaurav Mashruwala, a Certified Financial Planner.

Although investors get one month to exit, one must not sell out in a hurry. Ideally, one must watch the fund's performance under the new owner and then take a call.

INDUSTRY STRESS

A number of asset management companies, or AMCs, were caught on the wrong foot by the global financial crisis of 2008. "In fact, in 2008, there were worldwide layoffs in the industry because sponsor companies were not doing well," says Jimmy Patel, CEO of Quantum AMC.

Besides, the Indian stock market has been sluggish of late, leading to a consistent fall in assets under management, or AUM, of the industry for the last few years. To add to the woes, changes in the commission structure, especially the ban on entry load, have shaken the earlier distribution structure. Rising costs are also an issue.

Fidelity India's balance sheet shows accumulated losses of Rs 300 crore in March 2011. The loss for the year ended March 2011 itself was Rs 62 crore on income of Rs 70 crore. While business development costs doubled from Rs 8 crore to Rs 17 crore, commissions to distributors stood at Rs 49 crore, that is, 70 per cent of total income. These costs are significant.

"How these are managed needs to be seen," says Mashruwala.

These costs increase the fund's expense ratio, which lowers returns.

However, there is no way to know if your AMC is going to exit the business. A weak balance sheet does not necessarily warrant an exit considering that AMCs take years to break even. For instance, Pioneer Mutual Fund was doing well but exited. On the other hand, Apple Mutual Fund's parent company wasn't doing well and so it had to be sold.

"One must also take cognisance of the balance sheet of the sponsor," says Patel.

THE TRANSITION

A large number of AMCs launched India operations during the market boom of 2004-2008. When the going was good, distributors sold aggressively and earned commissions from entry load paid by investors, which acted as an incentive. In August 2009, entry load was banned, after which sales fell sharply as distributors had little incentive to push mutual funds.

To check slowing sales, a number of AMCs continued to pay upfront commissions to distributors from their own income, that is, the asset management fee. "Even an exchange-traded fund is theoretically pushed by distributors today," says Patel.

"If you earn 10-20 basis points management fee from these funds, how will you make money if you pay that to the distributor?" he says.

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