How fund managers walk the tightrope of guidelines
Fund managers are mutual fund industry's most celebrated figures.
However, they work within the rules and processes laid down by the fund
house and the mandate of schemes they manage.
Fund managers are mutual fund industry's most celebrated figures. However, they work within the rules and processes laid down by the fund house and the mandate of schemes they manage. These have a much larger bearing on returns than we realise.
Chintan Haria, senior fund manager, ICICI Prudential AMC, says, "We do not believe in taking cash calls. Our cash holding is limited around 10 per cent, except in funds that have a mandate to do so.
"Cash to us is a residual strategy. When we do not have a good stock to buy, we hold cash and wait for an opportunity to deploy it," says Huzaifa Husain, head, equities, AIG Investments, India.
Another strategy fund managers adopt to generate high returns is frequent churning, but not all fund houses give fund managers a free hand in this regard. A low portfolio turnover ratio means the fund manager is holding stocks for longer periods.
HDFC Mutual Fund schemes such as HDFC Top 200 and HDFC Equity have the lowest portfolio turnover ratios in the industry. The average portfolio turnover ratio of HDFC Top 200 in 2011-12 was 19.7 per cent and that of HDFC Equity was 33 per cent. Compare this to DSPBR Top 100 Equity's average portfolio turnover ratio of 251 per cent, DSPBR Equity's 185 per cent and Franklin India Bluechip's 65 per cent.
SAFETY VALVE
Leaving everything to the fund manager's strategy may spell trouble for the scheme if its fund manager moves on.
Having a basic fund management framework at place ensures a scheme does not collapse on such exits.
MUST SEE: India's Best Mutual Funds
The processes and rules relate to stock-picking, sectoral exposure, booking of profit/loss, churning and cash holding. Some investment restrictions are regulatory.
Then there is the scheme's mandate. For instance, the mandate it says the scheme will invest in large-cap stocks, the fund manager cannot deviate from this and buy mid-cap stocks. They of course have flexibility to buy or sell securities within these limits.
STOCK-PICKING STRATEGIES
The two stock-picking strategies adopted by fund houses are top-down and bottom-up approach. Some fund houses use both.
In the former, the fund manager looks at the overall economy and zeroes in on sectors and stocks that can benefit from the prevailing scenario. In bottom-up approach, the fund manager usually focuses on fundamentals of companies irrespective of the overall economic situation.
"We follow a bottom-up approach to select stocks based on fundamental research with a medium- to long-term perspective and ignore momentum stocks," says Anand Radhakrishnan, senior vice president and portfolio manager, equity, Franklin Templeton Investments.
Depending on the scheme's mandate and the fund house's strategy, a fund manager can either pick growth stocks (with good growth potential but high valuations) or value stocks (cheap with good growth potential) or both.
For example, Religare Tax Plan, a four-star tax-saving scheme, focuses more on growth-oriented companies. "We back growth-oriented businesses, particularly in the mid-cap space," says Vetri Subramaniam, chief investment officer, Religare Mutual Fund.
TEAM WORK
A team of researchers and analysts helps the fund manager prepare a list of securities that meet the criteria of the fund house and the objective of the scheme. The team also mines for stocks which can be a good investment and tracks companies in which the fund has already invested.
Each fund house has an investment panel that includes the chief investment officer, fund managers and research analysts. It reviews performance of schemes and market outlook as well as prepares the investment strategy.
This panel vets all investment proposals, which mention the background of the management, business outlook, financial analysis/valuation and reasons for the recommendation.
Neelesh Surana, head, equity, Mirae Asset Global Investments, who manages Mirae Assets India Opportunities Fund, says the research team contributes both in generating ideas and coverage of investee companies.
Apoorva Shah, executive vice-president and fund manager, DSP BlackRock Mutual Fund, says, "We believe that consistent application of our research and process will produce superior long-term performance with below-market volatility."
SECTOR EXPOSURE
Some fund houses adopt a sector-agnostic approach in which they use bottom-up stock-picking and do not take sector calls.
"Our focus is on quality through bottom-up approach rather than taking top-down sectoral calls and in that sense our sectoral exposures are a derivative of individual stock exposures," says Anand Radhakrishnan of Franklin Templeton. Fund houses like these may have a view on a large theme like domestic demand-driven businesses rather than a sector.
However, there are schemes which, depending on their objective and nature, can take conscious sector calls.
For example, UTI Opportunities Fund takes concentrated bets on four-five sectors. "Though there was a fund manager change in 2011, the fund's investment style and portfolio characteristics have remained the same-large-cap bias, 35-37 stocks portfolio and focus on four-five sectors," says Anoop Bhaskar, head of equity, UTI Mutual Fund.
ON TIGHT LEASH
Cash holding and portfolio turnover are two areas where mutual fund companies give clear guidelines to fund managers. A fund's nature and objective also have a significant bearing on the fund manager's cash strategy.
For instance, ICICI Prudential Dynamic Fund, a large- and mid-cap asset allocation fund, has a mandate for large cash holdings when equity markets are at a high. At the end of December 2010, its 20 per cent portfolio was cash. But for most equity funds, the cash limit is 10 per cent.The processes and rules relate to stock-picking, sectoral exposure, booking of profit/loss, churning and cash holding. Some investment restrictions are regulatory.
Then there is the scheme's mandate. For instance, the mandate it says the scheme will invest in large-cap stocks, the fund manager cannot deviate from this and buy mid-cap stocks. They of course have flexibility to buy or sell securities within these limits.
STOCK-PICKING STRATEGIES
The two stock-picking strategies adopted by fund houses are top-down and bottom-up approach. Some fund houses use both.
In the former, the fund manager looks at the overall economy and zeroes in on sectors and stocks that can benefit from the prevailing scenario. In bottom-up approach, the fund manager usually focuses on fundamentals of companies irrespective of the overall economic situation.
"We follow a bottom-up approach to select stocks based on fundamental research with a medium- to long-term perspective and ignore momentum stocks," says Anand Radhakrishnan, senior vice president and portfolio manager, equity, Franklin Templeton Investments.
Depending on the scheme's mandate and the fund house's strategy, a fund manager can either pick growth stocks (with good growth potential but high valuations) or value stocks (cheap with good growth potential) or both.
For example, Religare Tax Plan, a four-star tax-saving scheme, focuses more on growth-oriented companies. "We back growth-oriented businesses, particularly in the mid-cap space," says Vetri Subramaniam, chief investment officer, Religare Mutual Fund.
TEAM WORK
A team of researchers and analysts helps the fund manager prepare a list of securities that meet the criteria of the fund house and the objective of the scheme. The team also mines for stocks which can be a good investment and tracks companies in which the fund has already invested.
Each fund house has an investment panel that includes the chief investment officer, fund managers and research analysts. It reviews performance of schemes and market outlook as well as prepares the investment strategy.
We believe that consistent application of our research and process will produce superior long-term performance with less volatility than the market.
Apoorva Shah
Executive Vice President and Fund Manager, DSP BlackRock Mutual Fund
Neelesh Surana, head, equity, Mirae Asset Global Investments, who manages Mirae Assets India Opportunities Fund, says the research team contributes both in generating ideas and coverage of investee companies.
Apoorva Shah, executive vice-president and fund manager, DSP BlackRock Mutual Fund, says, "We believe that consistent application of our research and process will produce superior long-term performance with below-market volatility."
SECTOR EXPOSURE
Some fund houses adopt a sector-agnostic approach in which they use bottom-up stock-picking and do not take sector calls.
"Our focus is on quality through bottom-up approach rather than taking top-down sectoral calls and in that sense our sectoral exposures are a derivative of individual stock exposures," says Anand Radhakrishnan of Franklin Templeton. Fund houses like these may have a view on a large theme like domestic demand-driven businesses rather than a sector.
However, there are schemes which, depending on their objective and nature, can take conscious sector calls.
For example, UTI Opportunities Fund takes concentrated bets on four-five sectors. "Though there was a fund manager change in 2011, the fund's investment style and portfolio characteristics have remained the same-large-cap bias, 35-37 stocks portfolio and focus on four-five sectors," says Anoop Bhaskar, head of equity, UTI Mutual Fund.
ON TIGHT LEASH
Cash holding and portfolio turnover are two areas where mutual fund companies give clear guidelines to fund managers. A fund's nature and objective also have a significant bearing on the fund manager's cash strategy.
20 per cent is the portfolio turnover ratio of HDFC Top 200, one of the lowest in the large- & mid-cap equity diversified category
Chintan Haria, senior fund manager, ICICI Prudential AMC, says, "We do not believe in taking cash calls. Our cash holding is limited around 10 per cent, except in funds that have a mandate to do so.
"Cash to us is a residual strategy. When we do not have a good stock to buy, we hold cash and wait for an opportunity to deploy it," says Huzaifa Husain, head, equities, AIG Investments, India.
Another strategy fund managers adopt to generate high returns is frequent churning, but not all fund houses give fund managers a free hand in this regard. A low portfolio turnover ratio means the fund manager is holding stocks for longer periods.
HDFC Mutual Fund schemes such as HDFC Top 200 and HDFC Equity have the lowest portfolio turnover ratios in the industry. The average portfolio turnover ratio of HDFC Top 200 in 2011-12 was 19.7 per cent and that of HDFC Equity was 33 per cent. Compare this to DSPBR Top 100 Equity's average portfolio turnover ratio of 251 per cent, DSPBR Equity's 185 per cent and Franklin India Bluechip's 65 per cent.
SAFETY VALVE
Leaving everything to the fund manager's strategy may spell trouble for the scheme if its fund manager moves on.
Having a basic fund management framework at place ensures a scheme does not collapse on such exits.
CHECKS & BALANCES
- Each investment proposal is reviewed by the investment panel comprising managing director, chief investment officer, fund managers, etc.
- Details such as company background, business outlook, valuations and reasons for recommendation are taken into account before investing.
- The final investment proposals have details such as net assets of the scheme and extent of exposure to the company.
- The investment panel periodically updates the board of directors of the fund house and the trustee company to review the scheme's performance.
- The investment committee ensures that the fund manager invests the funds of the scheme in line with its objective and investors' interest.
TAKING NOTE In-House Processes Ensure Stability {mosimage}A major component of value creation for the investor stems from the proprietary processes, which an asset management company (AMC) develops to consider, select, manage and sell securities. Among other things, these processes are built to function within the regulatory framework, investment mandates and necessities of the market, making it a critical function for the company. The key objective of these processes is to mitigate the risk exposure of the schemes and also generate optimal potential return from the decisions made on allocations and investments. Process-driven investment and portfolio management has an essential place in an AMC. In absence of the processes, the decision-making will be individualised, and may lead to emotiondriven investment calls. Given the unavoidable emotional interference during investment decisions, the likelihood of increased concentration risk due to overoptimism or underplay due to excessive pessimism may skew the performance. Such constructed portfolios have the potential to cause relatively higher volatility. They may also lead to opportunity cost for the investor due to overlooked ideas. A well-established and regularly monitored process allows for specialisation of various functions required in the portfolio management process. It also dissipates the possibility of emotional response to an idea, imbibes a disciplined and dispassionate approach to investment and allows conviction driven investments. Such a systematic approach restricts portfolio volatility and bring alpha on the underlying benchmark. In Kotak AMC, we consider the inherent strength of the company based on its efficacy to conduct the business, the managerial expertise of its staff and the valuation it offers to the investor for the price it is selling at. On the debt side, our fund construction processes are built around providing risk-adjusted performance to the investor predominantly by means of institutionalised market expertise. The detailed supervision of investment mandates, performance criteria, positioning of the portfolio and transactions, among other things, are conducted by the compliance department on an almost real-time basis. The larger evaluation and periodic monitoring is conducted by three-tiered committees, namely the investment committee, the risk committee and the board. This ecosystem provides the AMC the necessary strength to shoulder the fiduciary responsibility even in times of serious market distress. Almost all major AMCs have structured their processes to optimise their fund management goals. The methods they adopt remains a unique determining factor that eventually begins to reflect in the comparative performance vis-a-vis the peers. Of course, as with all major policy decisions, reasonable time horizon must be accorded for its positive effects to be noticeable. SANDESH KIRKIRE CEO, Kotak Mutual Fund (This is a sponsored article) |
