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Photo: Mint

Blame it on RIL: Fund managers at pains to explain underperformance

  • Fund managers say 10% cap imposed on MF investments in one stock creates an anomaly
  • More so when there is no such cap in indices against which their performance is measured

You can make mistakes, but you are not a failure until you start blaming others for your mistakes," said basketball coach John Wooden. India’s mutual fund industry appears to be flirting with this cardinal principle.

According to CNBC-TV18, the Association of Mutual Funds of India (Amfi) has sought the creation of a new equity index where the weight of each stock is capped at 10%. Amfi, on its part was quick to deny the report, saying it hasn’t written any such letter to the markets regulator.

Nevertheless, some fund managers do say off the record that the 10% cap imposed on mutual fund investments in one stock creates an anomaly, especially when there is no such cap present in indices against which their performance is measured.

Missing the mark
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Missing the mark

In recent months, the weight of Reliance Industries Ltd, after a sharp bout of outperformance vis-a-vis the rest of the market, has risen to around 15% in the Nifty 50 index.

“An active fund manager of a diversified fund is poised to underperform in a scenario where one particular stock with more than 10% weightage in the index has given massive returns. And especially so when a fund manager can take only a maximum 10% exposure to the stock," said a fund manager with a domestic fund house requesting anonymity.

However, there has been criticism for this line of thought. “The 10% cap does create an inherent disadvantage, which may cause underperformance of a fund. Having said that, fund managers charge a fee to deliver returns better than the index, as they have the ability to choose stocks outside the index, so it is not correct to criticize the benchmark for a fund’s poor performance," said Sunil Subramaniam, managing director and chief executive officer of Sundaram Mutual Fund.

Singapore-based fund manager Samir Arora tweeted on Thursday: “I don’t see many of these funds at the maximum allowed weight (10%) even now, so why ask for higher allowance?"

As the chart alongside shows, a number of large-cap funds have relatively low exposure to Reliance.

Interestingly, Tata Mutual Fund’s large-cap fund has the highest exposure to the Reliance stock (nearly 15% because the value of the rest of the portfolio has fallen), but its returns have fallen far short of some peers in the past year.

On the other hand, UTI Mastershare has done well despite a mere 3% exposure to Reliance. This raises a pertinent point on whether the issue is of the construction of an index or whether fund managers fail to discern the main themes and trends driving the market.

Fund managers are well within their rights to ignore a stock that is popular on the Street, perhaps citing high valuations or weak future prospects. However, if these calls result in underperformance, they should be able to explain their strategy to their investors, rather than look for props such as a suitable benchmark index.

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