Mutual Funds and IPOs: Time for a re-think? | Mint

Mutual Funds and IPOs: Time for a re-think?

The investor whose hard-earned money is being funnelled into mutual funds, often one mis-sold SIP at a time, deserves a high level of transparency at the very least when it comes to how their money will be managed.. Image: Pixabay
The investor whose hard-earned money is being funnelled into mutual funds, often one mis-sold SIP at a time, deserves a high level of transparency at the very least when it comes to how their money will be managed.. Image: Pixabay

Summary

  • All fund managers who are chasing racy IPOs need to come clean on where their loyalties lie when it comes to the principles they follow when investing money

In recent days many of you, like me, were perhaps disappointed to see mutual funds come in as anchor investors in what I would call a racy IPO. However, I was even more disappointed when this adventure was rationalised by those that held sway over public opinion. There’s just so much wrong with this whole situation.

Let’s start with mutual funds coming in as anchor investors in racy IPOs.

Now, there’s no formal definition of a racy IPO. I, however, use this term loosely for IPOs coming in at the top of the market, for companies that have yet to demonstrate a solid earnings trajectory. In fact, such companies are often loss-making. But they offer a chance to make huge profits in the future, and hence, are available at a very high valuation (far far higher than what is generally acceptable). The picture I bet is so clear in your mind, that I do not even need to name any company for reference.

So, what’s wrong with mutual funds investing in such IPOs?

First, does the mutual fund mandate allow the fund manager to invest the retail investors’ money in such stocks? Let’s take the example of the recent racy IPO. If you go through the list of funds that bought the stock as anchor investors, you will find in that list a large cap fund, a small cap fund, and a mid-cap. And this is over and above categories like multicap, special situations, retirement savings among others! It appears that mutual fund mandates are just “fine print" and not really something that stands for anything. How could all these funds be buying into the same racy IPO! I know, I know, the guidelines probably have some wiggle room but I would be horrified if I as a conservative investor in a say large cap fund, found myself as an investor in a 100 P/E IPO small/midcap stock!

Second, is the argument that is being made by supporters of this move that the allocation to such IPOs is very small. In any case, mutual funds have done well over time, so we should cut them some slack for investing in such racy IPOs.

These views, in my mind, are rooted in ignorance and expose the other pitfalls of this move of investing in racy IPOs.

Take the point about a small allocation. Did the large cap fund which took money from you, take explicit permission that they will punt with your money, small amounts at a time, in racy IPOs of loss-making small and mid-size companies, with little visibility of sustained profitability?

Giving them the benefit of the doubt that they are experts and doing a great job, well, just smacks of complete ignorance. You see, the mandate of the mutual fund is not go to out and make a return no matter what. The aim is to follow the mandate and deliver what the investor signed up for.

If sheer performance gave everyone a pass, a lot of the scams in the stock market would pass with flying colours!

Next issue that comes to my mind is the fact that mutual fund managers are always quoting Warren Buffett (not necessarily the fund managers who invested in racy IPOs; I have not verified that) about how to be a smart investor.

Well, here’s Buffett on investing in IPOs:

“An IPO is like a negotiated transaction – the seller chooses when to come public – and it’s unlikely to be a time that’s favourable to you."

So, I think, all fund managers who are chasing racy IPOs need to come clean on where their loyalties lie when it comes to the principles they follow when investing money.

Having said that I want to be clear that under certain circumstances it may make sense to invest in racy IPOs. Perhaps a fund titled a Racy IPO Fund or something. And I am not being facetious here. Some racy IPOs may do well post-launch after all. The investor whose hard-earned money is being funnelled into mutual funds, often one mis-sold SIP at a time, deserves a high level of transparency at the very least when it comes to how their money will be managed.

The regulator has their hands full else this should be something they should act on. Perhaps a simple thing to do meanwhile would be, as Vivek Kaul, an economist, suggested, simply ban mutual funds from participating as anchor investors or in pre-placement offers in IPOs. I think this is a brilliant suggestion.

In conclusion, I would like to reiterate two investing principles that could work for you as a mutual fund investor at this moment.

First, not every SIP is created equal. SIPs are only a means to an end. Be sure to check where the money is being invested i.e. in which mutual fund scheme. If you are a conservative investor, and your fund manager is punting in racy IPOs, perhaps you were mis-sold the fund. Or more likely your fund manager needs to be reminded to treat your money with more care. So, drop him a line. Or switch to a better-managed fund. It’s your money.

Second, based on all the mutual fund data coming in, it’s very likely that you are over-allocated to small- and mid-cap segments of the market. The same segment where a lot of these racy IPOs land. While you may do well, you need to ask yourself whether you are prepared for large drawdowns – temporary, or permanent. If not, then get your asset allocation right. Don’t hesitate to give up short-term gains in favour of achieving your long-term objectives without having to ride a roller coaster.

I wish you a very Happy Diwali.

Rahul Goel is the former CEO of Equitymaster. You can tweet him @rahulgoel477.

Disclaimer: You should always consult your personal investment advisor/wealth manager before making any decisions.

Catch all the Business News, Market News, Breaking News Events and Latest News Updates on Live Mint. Download The Mint News App to get Daily Market Updates.
more

MINT SPECIALS

Switch to the Mint app for fast and personalized news - Get App