Even as the industry looks at trebling its size by 2001, investors have been systematically duped by the very guardians they entrusted their money with
At around Rs 85,000 crore, mutual funds could be sitting on the country's biggest scam. Ever. The victims: You! In an investigation undertaken by Outlook, we spoke to a whole host of mutual fund managers, financial intermediaries, stock brokers, and investors—both large and small. The findings are shocking.
THAT the mutual funds have been managed unprofessionally is only the tip of the iceberg. Insider trading, NAV (net asset value) manipulation, motivated investments, commissions going into private pockets, intra-scheme transfers, investors' money going into the companies of the principals are all part of the game (See boxes). In addition, absolute non-accountability, high-handedness, broken promises and a callous attitude in place of investor ser-vice are rampant.
Hardly any of the funds have been able to deliver a performance worth the fee they charge. Outlook analysed a group of 44 closed-end funds—funds that have a fixed lifetime after which they are wound up and the investments redeemed—that have been in existence for three years or more. The disturbing results: while two-fifths of the funds had their NAVs below Rs 10 (the price at which the average investor bought the fund's units), more than half the funds were being traded at below par. A decade after the industry was de-monopolised from the clutches of the Unit Trust of India (UTI), all that investors have with them are pieces of papers worth far less than what they had hoped for—and in some cases, been promised.
It didn't start this way, though. In 1987, public sector banks and insurance companies were allowed to set up mutual funds. It wasn't until three years later, however, that schemes were actually floated by these funds. Thus, Canbank Mutual Fund (MF) came out with Can growth, Ind Bank MF presented Ind Ratna, SBI MF offered Magnum Multiplier and GIC MF floated GIC Rise 91, among others. Most of them were fixed-return instruments.
The public response was overwhelming. Reason: without understanding the instrument, small investors went overboard. Their folly: a belief that mutual funds—like the IPOs (initial public offerings, or public issues) had in mid-'80s and early-'90s—would multiply their money many times over, a faith that their savings were safe in these funds, a confidence that they would be able to investin the best shares available—an option that they, as individual small investors, would not be able to exercise. Thinking that they were investing in the principals—like Canara Bank, State Bank of India, Indian Bank, General Insurance Company—they were secure in their minds that the investment would be safe. The fact that mutual funds are by nature risky instruments, and the size and stature of their principals have nothing to do with it all eluded them.
It eluded the fund managers, as well. Being largely ex-bankers, they were a risk-averse lot, laying more stress on security than on growth. Thus, income funds, which largely deploy the money in fixed-return instruments like bonds, have done better than growth funds, which seek capital appreciation on the stockmarkets.
Worse, there was no training provided to the managers. In India's traditionally government-controlled and thoroughly predictable capital markets, this may not have had serious effects, but the country was now ushering in economic reforms. On the stockmarkets, the turning point came with the abolition of the office of the Controller of Capital Issues—once the guardian of public issues—the creation of Securities and Exchange Board of India (SEBI) and its metamorphosis from being a toothless tiger to a feared watchdog. Rules, regulations, the very business environment changed dramatically and fast, and the clear need was of true investing skills.
But first, some basic questions: just what is a mutual fund? How does it work? Why is the industry so important? Why should you invest in them? Most important: Why should an honest and corruption-free working of the funds be a top priority for authorities?
Mutual funds are financial vehicles that pool the money of millions of investors into other instruments—stocks, bonds, securities, money markets—generate earnings and returns from them, and pass it back to the investors in the form of dividends, capital appreciation or both. For this, they charge amanagement fee, of 1 per cent of the corpus, in addition to an upfront payment of around 6 per cent (some recent funds are not charging that). In return, the benefits investors get are:
Quite a job. Naturally, therefore, trust is the basic premise on which the relationship between the fund and investors rests. Reason: you are handing over your hard-earned money to the funds for efficient management. You are paying for these services, and your expectations must be met. Of course, you have to realise mutual funds do not operate like a casino.
Inefficiencies and blunders can be expected out of any industry, and mutual funds are no exception. But every mistake is an opportunity to learn—and prevent it from happening again. When these bloomers keep on cropping up with uncanny regularity, there is cause to question.
Outlook did that. And found that behind the poor performance is not merely an inefficient system of checks and balances, but at places even methodical scams.
UNPROFESSIONAL: The story starts with PSU funds, where inept executives were made the guardians of your money. The first two chief trustees of one of the PSU funds were inadequately qual-ified: one was a simple graduate, the other, a sugar technologist; both had no experience or training on the market. The upshot: a pathetic dependence upon brokers to direct investment. Thus, purchases were made not on the basis of any systematic analysis of companies, but on broker fancy and market gossip. The main beneficiary in this game of ignorance was the broker, who not only was paid the commission for transacting the orders, but also indulged in insider trading.
INFORMED OR INFLUENCED? It is very difficult to track scams in this industry. How, for instance, is anybody to guess whether aninvestment in Reliance Industries at around Rs 400 per share with a lock-in period of five years, when the share is actually quoting at around Rs 300, is an informed decision based on extensive research and long-term company prospects, or an influenced decision? In one mutual fund, apart from insider trading, the bigger racket involved putting money in IPOs. Top officials were apparently paid anything between 5 per cent and 10 per cent of the total sum, with executives down the line getting gifts worth Rs 20,000 each.
MURKY DEALS: One fund invested in the rights issue of a company K. Per se, the company is not bad, with a fair track record. But the way the deal was struck was unethical. Apart from the fees, the company's merchant bankers—who market the share issue to investors—were to be given five lakh shares of K. The condition: they would not offload the shares till a certain date. Then the price of K was propped up through market operations. Meantime, the company had a tiff with the merchant banker. As a result, another merchant banker was given the mandate. Once this happened, the previous merchant banker offloaded the shares in the market, bringing the price down. The rights issue scraped through with the promoters having to pick up the shares that no one else wanted to buy. To get rid of these unwanted shares, the managing director fell back on his "links" with the chief of the mutual fund. He offloaded to the fund for Rs 20.Today, K quotes at less than half that much.
EXPERTS? Of the 44 funds that Outlook analysed, it found that the average annualised NAV growth of all the funds was a miserable 1.9 per cent. On the price performance side, on an average, the funds displayed a negative trend,falling by 1.7 per cent per annum. The current average discount to NAVs—the difference between the NAV and the market price of the mutual fund share—stands at almost 15 per cent. Many fund managers claim that a discount is a global feature. But the degree of discount is not so steep. To evaluate the industry performance, just take a look at the returns promised by various funds, watch where they are, and observe deeply how they are simply backing out of the commitment.
WHO'S ACCOUNTABLE? In the case of PSU funds, socialist economics has prevented any accountability. There is no fund manager. Instead, there is a committee that decides upon each and every investment decision. This leads to a time gap, and if anybody makes a mistake, he cannot be pin-pointed. The fund's trustees have the responsibility but no power. Quite often, many trustees have moaned about the lack of knowledge of the working of the fund. Abroad, if the investors are not happy with a fund manager, they ask the trustee to change the manager—and this happens often enough. This is, of course, unheard of in India.
ARE PRIVATE FUNDS BETTER? The short answer: No. Of the 44 funds Outlook investigated, not a single private fund managed a place in the top 10 of investment performance. The first private fund selected on the basis of average annual increase in NAV came only 20th. Again, expectations out of the new private foreign funds are high, but for lack of data, we have not included them in the analysis.
DISCLOSURES OR CONCEALMENTS? The industry as a whole reeks of poor disclosures. Few mutual fund investors can ever get to know what the fund managers are doing with their money. It is only recently, that is, after SEBI insisted upon annual disclosures of portfolio and regular NAV declarations, that the funds are coming on track. Perhaps it is the lack of competition in this business. Abroad, it is not regulations but marketing needs that force funds to disclose to a fair degree what the portfolio comprises, and even a brief outline of why the fund has invested in a particular company. This gives comfort to investors.
The funds' initial performance was fair, but only by sheer accident. In 1992, the Harshad Mehta-led boom pushed stock prices to an unforeseen high. The funds, consequently, generated supernormal returns. Then the markets crashed. But the funds had made a killing. There were two main reasons for this. One, it was the regime of the CCI, where issue pricing was completely out of sync with market forces. Two, they had been able to garner good PSU stocks cheap from the disinvestment programme.
Despite this, the funds had started bleeding their portfolios dry. This was done by selling good stocks in order to generate dividends. After the third quarter of 1993, these problems came to the fore. With the CCI dumped, and the arrival of free pricing, premiums on issues rose significantly. The funds started benchmarking against one another, chasing the same stocks. And, often, losing. (A fund misses the bus at Rs 50, and the stock climbs to Rs 100, with talks of it going to Rs 200. It enters at Rs 100. The stock rises to Rs 150. It doesn't sell.
The price promptly falls back to Rs 50.) Moreover, most funds operate under group umbrellas. So, the bankers to a company ask it to use its merchant banking arm to lead manage its issue, which in turn asks the asset management company—which actually manages the mutual fund's investments—to buy large numbers of shares from the issue. This supposedly imparts credibility. At times, the firm allotment is at a price higher than that offered to investors. It does not matter if the company has no track record, if the promoters have a shady past, or if the project viability itself is suspect. Remember, the asset management company is using investors' money—not the promoter's—to help the issue go through
The industry has been bumbling along the learning curve. The lack of professionalism has metamorphosed into a full-blooded scam. Promoters who had entered this business with hopes of harbouring monetary clout are today watching their brand equity being rapidly eroded. Executives are making merry, hand-in-glove with shady companies. Funds are being grossly misutilised, with no sense of accountability. New funds ask you to look at track record. But soon, they too join the ranks. By 2001, this industry is expected to grow over 3.5 times to Rs 300,000 crore. And standing outside all this is the average small investor—the sole reason why mutual funds exist in the first place. Question: should you be entrusting your money to these people? Figure that out.