Why staying on top is a difficult thing?
by Vivek Kaul/DNA Money
No wonder high returns are nearly as perishable as unrefrigerated fish
— Jason Zweig, in the commentary to Benjamin Graham’s ‘The Intelligent Investor’
Sanjoy Mitra, a fund manager with a leading mutual fund, was getting ready to go to office. As usual he could not find his tie. After more than a decade of working he was still clueless as to why did he have to wear a tie?
The British left India almost six decades back and in that time we had become more British than the British themselves. But right now he had bigger problems to worry about.
The diversified equity mutual fund scheme he managed had done exceptionally well in the last one year. This had led to retail investors and corporates pouring in more money into the scheme.
How ironical this was? In late 2002 and early 2003, when he could see that the market was ready to take off, there were hardly any investments coming into the scheme.
Back then he had so many ideas. But there was so no money to execute them.
There were so many stocks in the market which if picked up would give fantastic returns. And now that he had the money, those ideas were really not relevant anymore.That’s the way it worked.
Mitra remembered reading in a book titled Face Value, written by Debashis Basu, “Retail investors always hand over money to fund managers when the market is going up making it harder for the latter to perform”.
When a mutual fund scheme does well, investors pour in more money into the scheme. As assets under management increase it leaves a fund manager with fewer options to invest money in.
If he decides to retain the money as cash, and the stock market keeps going up, the returns of the fund go down. If he decides to invest in a stock which he already owns and which would have probably gone up in the meanwhile, his returns are again less.
When he invests in such stocks there might be a danger that they might become overvalued.
The last option is to buy stocks which the fund manager would not have bought in the first place.
Further as more money comes into the scheme, executing larger trades becomes difficult, leading to higher expenses.
As Jason Zweig points out in the commentary to Benjamin Graham’s all time investment classic, The Intelligent Investor, “It often costs more to trade costs in very large blocks than in small ones; with fewer buyers and sellers, its harder to make a match.”
As a mutual fund scheme becomes successful, the fees that the mutual fund earns becomes more lucrative.
Says Zweig, “As a fund grows, it fees become more lucrative - making its managers reluctant to rock the boat. The very risk that managers took to generate their initial high returns could now drive the investors away — and jeopardise all that fee income. So the biggest funds resemble a herd of identical and overfed sheep, all moving in sluggish lockstep, all saying “Baaaa” at the same time.”
Further the performance of a mutual fund is benchmarked to an index.As Basu points out in his book “Performance is benchmarked to an index - the mass market behaviour. To be wrong, when everyone else is wrong is not such a bad thing. Hence everyone focuses on the same numbers, similar stocks, surfing the latest fad.”
Mitra understood all this. But this was not what he was really worried about. A rival mutual fund, seeing his excellent performance over the last one year, had given a great offer to switch over.
Make hay while the sun shines. Isn’t that what the Britishers say?
(The example is hypothetical)
