Mumbai: Investor Nijalingaraju Cholappa bought 6,000 units in a new fund offer, or NFO, from an asset management firm in December 2007 for Rs60,000. Earlier this year, he sold those units for Rs16,000, writing off 73% of his investment.
Cholappa paid his fund managers an investment management fee for two years and the agent who sold him the units an upfront commission. The scheme’s net asset value, or NAV, still hovers around Rs3. Investors enter new fund offers at an NAV of Rs10 per unit.
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“I was fed up and decided to exit three months ago,” said Cholappa, a self-employed professional in his 50s.
Investors such as Cholappa, who invested in NFOs at the height of the stock market boom that took the Bombay Stock Exchange (BSE) to a lifetime high in January 2008, have been among the worst losers in the subsequent years. Even those who invested at lower levels in the past two years have no hefty returns to show.
The Bombay Stock Exchange’s benchmark index Sensex crossed 20,000 points in December 2007. It fell to 8,160 in March 2009 after an unprecedented liquidity crunch gripped global markets and foreign investors fled India, selling a net $12.18 billion (Rs56,637 crore today) worth of equities.
The Sensex has doubled in the past one year, but the NAV of many NFOs is still below their face value. According to a Mint analysis of 220 NFOs of diversified equity schemes launched since 2006, at least 35 schemes still have an NAV of Rs10 or less. This means investors in these schemes have either not made any money or have lost money.
“Distributors tend to shift investors’ money from one scheme to another whenever a new scheme is launched. The customers are generally clueless about selecting one out of a vast universe of schemes,” said the managing director and chief executive officer (CEO) of a private bank controlled asset management company.
During a large part of 2008-10, the markets were volatile and the NAV of many schemes fell more often than it rose. With every NFO being launched, mutual fund agents sold new schemes to existing customers to earn upfront commissions.
The number of NFOs peaked in the first quarter of 2008 when 28 schemes were launched. That trend tapered off with the market declining. In the next nine months, 34 more schemes were launched. In 2009, 33 NFOs hit the market. In 2010, six equity NFOs have already raised money and two more are currently open.
Capital market regulator Securities and Exchange Board of India chairman C.B. Bhave said last week at a mutual fund summit that the industry’s short-term incentive structure has been working against investors’ interest.
“There are 3,000 schemes. Is so much of financial innovation happening or is it driven by short-term nature of incentive structures that are driving people away from what the customer really needs?” he asked.
Skewed incentive structures ensured that people were advised to invest in new schemes that had no track record. They were churned into newer schemes before the schemes could build the critical mass necessary to deliver the benefits of aggregated savings to investors. Such churning led to the closure of 400,000 investor accounts in the past few months.
According to a recent study by Boston Consulting Group, 50% of NFO investors exited with losses between April 2008 and March 2010. During this period, Rs6,993 crore was redeemed by investors in NFOs. Of this, 42%, or Rs2,938 crore, was redeemed at an NAV of Rs9.50 or less. This means these investors made a loss of at least 5%.
Some Rs464 crore, or 7% of redemption took place at an NAV of less than Rs10, but more than Rs9.50. In comparison, out of the total redemption of all schemes (NFOs as well as the existing ones), only 28% was made at a loss. This means schemes with a longer track record have fared better than the NFOs.
According to Lokesh Nathany, senior vice-president, head of sales and distribution at Motilal Oswal Asset Management Co. Ltd, investors would have exited as their investments in a number of schemes focused on mid-size companies. “These schemes might have lost money during this period when the equity markets were volatile,” he said. Motilal Oswal Asset Management last week launched its first NFO.
“Good advisers have helped people to stay invested through the crisis in 2008 and recover the losses in the upturn in 2009,” said Vivek Kudva, CEO of Franklin Templeton Asset Management (India) Pvt. Ltd, which manages some Rs35,775 crore. “But people who were mis-sold complex products exited in downturn and made losses.”
Despite the dismal record, fund houses continue to launch NFOs. In the past few months, at least 10 new equity funds have hit the market. Many of these NFOs are from established fund houses such as DSP Black Rock Investment Managers Ltd, IDFC Asset Management Co. Pvt. Ltd and SBI Funds Management Pvt. Ltd.
Fund houses find it easier to market so called “new ideas” to incentivize agents with upfront commissions and push products. Upfront commissions continue to be paid by asset managers out of their pocket. Until the capital market regulator banned the practice in August 2009, fund houses were incentivizing agents out of investors’ money.
Although some fund houses tried to market old products, based on their track record, this practice was dropped once the market started looking up.
The Sensex has doubled since its March 2009 lows, but since January it has remained range-bound, gaining just 0.63% till Friday’s close of 17,574.
NFOs accounted for 100% of net fund flows to the industry, and at times even exceeded net inflows, between 2006 and 2008. Net inflows count the money that flows from new schemes as well as old schemes, minus redemptions from old schemes.
Graphics by Ahmed Raza Khan/Mint