The Mutual Fund Show: Do Investors Suffer If Distributors Stop Selling Schemes Of A Mutual Fund?

What if a mutual fund distributor chooses not to offer schemes from a particular asset management company?

Pencils are displayed for sale at a store in New York, U.S. (Photographer: Chris Goodney/Bloomberg)
Pencils are displayed for sale at a store in New York, U.S. (Photographer: Chris Goodney/Bloomberg)

What if a mutual fund distributor chooses not to offer schemes from a particular asset management company?

According to Tarun Birani, founder and director at TBNG Capital Advisors, that would not be in investors’ interest. “Buying a mutual fund scheme from an adviser is like a prescription-based medicine, and if an adviser doesn’t give out all the options, then investors would be taken for a ride,” he said on BloombergQuint’s The Mutual Fund Show.

The Securities and Exchange Board of India reduced total expense ratio—or fees paid by mutual fund investors. There have been reports that some distributors have stopped selling schemes of fund houses that offer low commission.

But Amol Joshi, founder of PlanRupee Investments, doesn’t expect much of an impact. Investors will eventually find a way to buy the product they would want to, he said.
The two investment advisers also explained tax arbitrage between debt alternative investment funds and debt mutual funds and the impact of the recent slide in the equity market.

For Birani and Joshi’s take on thematic funds, tax arbitrage between debt alternative investment funds and debt mutual funds, and recent market correction, among other things, watch the full video below:

Here are the edited excerpts:

A lot of people have been talking about the kind of correction that has happened, into let’s say, autos for example, that’s one sector that has caught the eye of the storm because it has created a lot of wealth, and has gone down in the last, 18 odd months and there is no stopping because the response around, whether it is the end of down-cycle or beginning of a potential up-cycle is not there. Even the auto companies are not able to say that. So, I would not believe anybody else right now. What to do in such a scenario with funds that have got a high exposure to some of the auto stocks?

Tarun Birani: So, auto if we look at it from a Nifty perspective, Nifty has a 5 percent weightage in the auto sector. When we look deeply around mutual funds, equity schemes, we have seen that some schemes have maximum 7-9 percent. So I don’t see most of the fund managers themselves are very bearish about the auto sector which is clearly visible and there are two-three bellwether stocks in the auto segment and the large cap side for example, Mahindra and Mahindras of the world, Marutis of the world which at one point of time were trading at a very rich valuation. Looking at the tepid growth from last two-three quarters and the continued negativity due to the concerns like NBFC sector where there is no credit available to the last mile customer who would be looking at buying an automobile. So that is one reason and the second big reason had been because of increase of prices because of BS-VI norms as well as the insurance and all of this is letting auto prices moving up dramatically. Due to that, the overall demand side if we look at, I think the last two quarters we have seen most of the auto companies delivering almost 20 to 30 percent negative growth numbers. De-growth is happening there. So, looking at all this, I see that auto will continue to do badly for the next two to three quarters and any schemes and funds which are overweight on auto need not be part of your portfolio that needs to be looked at.

Amol, some of those NAV would already have corrected in line with what the auto stocks have done. If you, by chance, have this scheme, so Taun’s point is well taken, it shouldn’t be a part and therefore don’t buy them. What about the schemes that are already there? Is the damage to NAVs already done to your mind or do you reckon it is a good thing to get out of those and get into something else?

Amol Joshi: So, as Tarun mentioned, over index, you have a weight of around 5-6 percent for autos, most of the schemes have about 8 to 10 percent sort of a weightage number. Secondly, since mutual fund is a daily NAV product, so any damage you have seen in the stock prices has already reflected into NAV, exiting today. If you don’t have any view, it does not do any good to your portfolio. If you have a view that the auto sector will continue to underperform the broader markets, then probably you can look at exiting but my advice, always, whenever you are not sure, go by the book. If equity is not part of your portfolio, and you know that markets are going to be volatile. There might be phases where they might be extremely volatile, there might be phases where it just goes one way up. In both the cases, stick to your asset allocation. No point of exiting when the damage is already reflected into your NAVs and your portfolios.

There are some schemes, for example, the graphic that we have has about five or six schemes, wherein the percentage of auto is part of the total asset. It is significantly higher. Now what I understand, Reliance tax saver, it’s a tax saving you cannot get out without the timeframe. But the others, irrespective of how good they are simply because the auto space is dragging lower. Would you recommend that? It might be prudent to look over some other schemes.

Joshi: Now, lets read out the names. One fund is Transportation and Logistics Fund, the other one is close-ended fund and the next two-three ones are consumption-theme oriented funds. So, in all these fund names, the name clearly tells you that these funds belong to a specific sector like transportation, the first scheme or these funds belong to a specific theme, that is, consumption. Now, one of the earliest episodes of mutual fund shows that we have done, if you have to ask about a sector, don’t invest into it. You might recall one of our oldest discussions on the topic. If you have taken the exposure to consumption theme, then you cannot just be a part of that theme when the going is good. You’ll have to see both the good days and bad days, and I also hope that you had taken some of the advice that we have given over a period of time. Any theme or sector cannot be a core part of your portfolio. So, if you have any of these schemes, I can only hope that these schemes do not form a part of 60 percent or 90 percent of your portfolio. At best, they should be about 10 percent or so. If you have something like that, an exposure to that extent, you shouldn’t really worry about. If you have done excesses in terms of asset allocation, then probably this is, again, the right time to correct it to a certain extent.

So, one part is not to be worried about, some of the damage is already done. Other part is, why can’t I be pro-active and do something about it and therefore, from a perspective of somebody who wants to do something about it and doesn’t want to have a basic formula of asset allocated and therefore, ‘I will wait, let me ride’. So, if I want to make the most of this from some of these funds, is it better to get out even now?

Birani: So, my sense is, as Amol rightly mentioned, the damage has already been done in most of these schemes. Since they are sectoral schemes, I am sure that if anybody has invested through advice, they must have given just 5 percent or 7 percent of the portfolio. So, I am sure that part of the weightage anyway the Nifty also has in auto.

Some of them have 20 percent as I was wondering

Birani: Yes. But I think in your portfolio it would not be more than 2-5 percent. I am assuming. Most of them have not gone and invested 30-40 percent of their portfolio. If that is the case, then it is a worrying sign, they should get out of it. Otherwise, I don’t see that as a big problem.

Joshi: I am repeating that all these schemes are sectoral or thematic. This is not a core part of your portfolio, if you have done excessive in allocation, you can still go ahead and correct it. I mean get the weightage down to below 10 percent. If you have been sticking to it, then your overall portfolio will be a single digit allocation which you should not worry about.

So, that seems to be a broad sense of autos. Now, IT again, a large portion of the index as well, a large auto-index weightage is considered to be defensive to its nature, and more so right now and companies have largely not been doing all that poorly. What does one do with schemes that have a slightly higher exposure to IT?

Birani: if you look at it largely, IT as part of the index, it is at least 15-16 percent of the portfolio and I think most of the schemes if you look at, the portfolio varies between 15 to 20 percent of the portfolio. I think IT as a sector to my mind is more neutral right now and more as defensive. Most fund managers would be looking at pharma and IT as their saving grace at this point of time. I think one can continue with that, no need to look at it much more deeply.

Joshi: Niraj, in your question you mentioned the defensive sector. When you have the defensive sector as a worry, then again, the problem is something else. Over the last few days, especially with the rupee depreciation, as Tarun rightly said, in fact the allocation in these sectors, export driven sectors, that sector’s allocation has been your saving grace. There is another point. See, auto is not doing well, 5-7 percent of the portfolio, IT is not doing well, 15-20 percent of the portfolio. You cannot really keep away from one, two, three-four sectors then you will not be left with much. One of the biggest components which is, let’s say 35-40 percent which is banking services.

What I was trying to figure out was, there is a way unlike autos, there is a way to play IT thematically, via these technologically-oriented funds or these technology funds. What to do with these funds? There are four to five names which are well, over 50-60 percent, at times over 85 percent. Pure exposure to IT because those are technology funds. what do you do there?

Joshi: Again, if your fund is having 75-88 percent, then it clearly is a digital fund or a technology fund or technology opportunities fund. It is a thematic fund. Thematic funds, we have seen this story play out over and over again. So, this is the same thing that happened to infrastructure theme in 2008. In 2006-07 you got handsome double digit and in some cases 100-120 sort of a return and those schemes have not been doing well for quite a lot of period of time. Infrastructure I am talking about. Similar thing, defence sector when you over-allocate to it, that sector compared to a broader economy, those sectors are more prone to volatility because simply, there can be technological disruption, there can be legal or geo-political changes, there can be a new product that comes and wipes out what you have been doing. So, you have to be mindful about this before the portfolio construction stage. If you have invested in a digital or technological fund, especially of the rupee scenario that you are currently holding, I would say that you should hold till the time of your investment horizon.

Birani: One big point I want to make because we are talking about sectoral funds, in the question that you asked that, what to do for people who have already done it? My advice would be, we have done that study as well. If you invest in sectoral fund versus a diversified fund, one is the standard deviation. The risk portion is very high in the sectoral funds. So, my suggestion would be, people should generally avoid sectoral funds. Sector funds are not for the fainthearted. It is for somebody who is ready to accept a volatility like, in the automobile sector, you see in the logistics funds which are having 30-40 percent of the portfolio. I don’t think retail investors, or the general investor, has that kind of an appetite. Similarly, for IT fund also, a 70-80 allocation for most of the tech funds is in these stocks. So, my suggestion is, to avoid completely for normal investors, these sectoral funds are something from what one should stay away. They should focus more on diversified funds.

Now something that came across, in a few images to us, you know how the stock of a certain state body or a distributed associations or mutual fund adviser associations have banned select AMCs from getting sold. Now, it won’t impact in a direct way but since we talked about people who take advice of the advisers like yours. What’s the impact of such moves from an investor’s perspective? Let’s say, we saw for example an image that said that, this was Kerala, the state of Kerala had banned, I think one of the large AMC schemes etc. What happens in such a scenario? Maybe the sales don’t happen, maybe the other funds don’t get more AUM. How do you approach such a scenario from an investor’s perspective?

Joshi: Neeraj, this is very important. If you say from an investor’s perspective, investors today have a problem of plenty. Investors get advice from banks, investors get advice from independent financial advisers, investors can get advice, as in, advice, data from any name from various websites or online avenues that you have. If a particular distributor chooses to not work with a particular service provider or a particular AMC, investors have to be very clear in their mind. If an investor wants ‘XYZ’ large cap fund and if the distributor is not able to offer, the investor can definitely go to another channel or go and buy from the fund house or any other way.

But the investors may solely depend on that adviser’s advice when it comes to it?

Joshi: Any ethical or professional outfit be it a one-person outfit or be it a state sort of distribution body will always put the investor’s interest ahead of any business considerations that you have. We are still not talking about boycott of any particular AMCs, we are still not talking from a distributor’s point of view. We are still talking from an investor’s point of view. Any channel, any intermediary who acts on ethical parameters or with ethics as a base will never compromise on a particular product or asset allocation. If XYZ large cap fund has to find a place in that investor’s portfolio, it has to be incorporated.

But Tarun, the truth is, we have kind of seen, apparently some state associations at large. Large bodies saying that, ‘we won’t do this’. So, ethics is one good thing to speak about, but we have not seen that at large right?

Birani: I had a slightly different perspective, the diagnosis of this problem what you’re talking about, basically started with the TER changes. With the TER changes, a lot of large fund houses become unattractive for a lot of advisers, distributors due to reduction in the rates and all that. Due to that I think the smaller fund houses suddenly became very attractive for a lot of distributors and due to that, we have seen a lot of distributors or the state bodies which you are talking about, I think they found merit in banning something like this. I don’t know the details of it, but I think, prima facie it looks like because of the reduction in the brokerages and the distribution commission, there has been banning and all those things. A larger solution I think, globally this independence part is always a question mark. That whatever is advised to the client, how independent that advice is. I think for that, the conflict of interest has to be reduced dramatically. Wherever the conflict of interest is less, I think investor will earn more in that exercise. The RIA as a concept, registered investment adviser as a concept, which has been, I think in the last five years, India has also adopted that system, and we are seeing a lot of suitability around that exercise, wherein, any advice that is disseminated, is completely independent of what you are going to earn. If you are earning, that disclosure anyway needs to be made but apart from that, try going more through the direct route. I think the direct route helps in earning most of the earnings directly from the customer other than earning from a manufacturer. That again puts the investor-first concept into place. And I see going forward, next three to five years, in the U.S. and U.K. this is changing dramatically and in India it is moving towards that. This problem what you’re saying, the banning and all of that, will not arise if the investors are using services of RIA.

But you guys are largely of the belief that investors, by virtue of the awareness that is there, will easily move on to the online platforms to try and find out.

Joshi: Investors will eventually find a way.

Birani: No, I don’t think so. It’s a prescription-based medicine, not everybody has the wherewithal to understand this. So, you need someone qualified to talk about it and if the qualified person is not talking about it, the investor will be easily taken for a ride.

The tax arbitrage or the AIFs in debt mutual funds, arguably for large HNI investors, nevertheless might impact others as well. What are your thoughts on that?

Birani: So, lets understand the AIF structure. The AIF structure in India is more like the trust structure. The trust structure, the highest tax rate applicable to them is more than Rs 5 crore type of taxation structure which is 42 percent-plus. Compared to a dividend distribution tax of 29 percent, I can clearly see a 13-14 percent tax arbitrage available. So, a 15 percent return, earned by let’s say a debt AIF, at the end of the day, the post-tax returns would be 8-8.5 percent return. It makes it unattractive for anybody to look at it. This is a challenge in the current market due to the unintended consequence of whatever the finance ministry wanted but what happened turned out pretty negatively. I hope they change it. At the end of the day, a debt mutual fund or debt AIF are going to invest in a debt structure, so they need to have a parity in terms of taxation. This arbitrage will not exist for a long term.

What happens in such scenario to the kind of interest that is there in debt mutual fund and therefore a retail investor would anyway take advantage of that or is it even.

Joshi: When we say retail investor, AIF is not even really a retail product because of the size. Super HNI, super edge product because the minimum ticket size is Rs 1 crore. If you talk about retail since retail cannot go, retail will continue to do what it is doing.

Have your clients asked you and have you advised them to switch to the debt mutual fund?

Birani: First of all, this is for client’s worth net more than Rs 15-20 crore, a debt AIF is for people who have net worth more than that. We have looked at equity AIF but that AIF we have not advised for a reason. Debt AIF came into place because of something that is on a low credit play so the real estate structures and all those things. So, in the current market scenario, the existing AAA structures are facing this kind of an issue. For us to advise something like this is anyway out of question now.

Amol, do you agree?

Joshi: Yes, I certainly do. If you have to take higher risk, then why to take that higher risk on debt side. It is also a very important question. Debt we have always said is basically to preserve your capital as well as to try to earn an F+, PPF+ sort of return simply because of staying put for three years and using the indexation tax benefit. If that is clearly available in an open-ended product like debt mutual fund, there is very little other reason, other incentive to go to. Higher risk and products will lock in.

Birani: There is a huge disservice to the economy, if I look at it from a larger thing. We have a lot of sectors in our economy which need this kind of long-term capital and if it suddenly becomes unattractive due to this arbitrage available, I think the larger flow of funds moving towards these sectors goes negative. So, this is from an economic perspective again it’s very negative and I think I have gone into more than Rs 70-80,000 crore of debt AIF as of now.

Correction in funds with high AUMs, we have seen or heard that higher the AUM is difficult for that fund to really perform meaningful in case of PMS schemes. In mutual fund schemes, there are some schemes which got higher AUMs and have seen a sharp correction as well, what would the advice be to the clients who have probably owned some of those funds and have seen the AUM correction.

Joshi: I am afraid at least in this show, it is more or less the same. You have to understand why the correction has happened. From last year, let’s say from June 2018 to July/August 2019, we have seen broader index going up by 8-10 percent which is majorly doing a few handful stocks even in large cap index you have many stocks. I think the advance decline ratio will be 1:2. For every 10 stocks that have gone up, 20 stocks are currently down in large caps. Coming to mid-cap in broader market you have had between 20-35 percent correction and in some small cap you have 30-50 percent sort of a correction. When you have invested in equity, I am sure in 2016, mid-caps are given 40-60 percent sort of a return. In calendar year 2014, you had mid-caps delivering 40-60 percent sort of a return. You were clearly a part of an era when valuations were not really attractive, valuations were on a super-premium standard division 1 and standard division 2 level. If you had done asset allocation or if you had not done the asset allocation, then you are not facing this problem currently. All the correction that has taken place in large funds, I would imagine those funds typically are on mid cap side or multi cap side. Multi cap side also had a mid cap and also corrected by 30-35 percent. Multi-cap has close to 40-50 percent of mid- and small-cap exposure. I have no other prescription or no other way than to say that if your investment horizon permits then you should stay in the course because you cannot just take me away from auto you cannot be away from IT, you cannot be just away from diversified also. Then just the entire investment equity thesis we are spinning on its head. You have to ride this volatility. This is trial by fire. Unless you go through this, you are not really looking at earning 10-13 percent sort of a return which, if you ask me, is just not available in any retail instrument that is currently available in India.

Birani: We have to quickly do the attribution analysis of the correction you are talking about. Is this correction because of the AUM size or is it because of the capitalisation nature of the funds? So, clearly I have a viewpoint that large cap categories or the multi-cap categories can run fund houses with more than Rs 10,000 crore - Rs 20,000 crore can also easily run in both these categories but mid and small categories due to the impact cost, I think the larger AUM funds cannot continue to deliver long-term return. So, now the question which you asked is I think it needs to be dissected which kind of fund are you talking about in the correction. If the correction you are talking about is it because mid- and small-cap fund, it is largely because of the markets. We have seen a 30-40 percent fall in the market. For large-cap fund I don’t see the problem; It is because of larger AUM funds that it has happened. But in mid- and small-cap funds, my suggestion would be that fund houses with a larger AUM should be avoided because the impact cost to sell or buy is very high in those cases. So, they can actually impact the stock weightage. So, large and multi Is ideal one for the large AUMs.