Scroll Down

When the desire to maximize returns blurs fund mandate definitions

Roopali Prabhu , Head of Investment Products , Published Apr 19, 2016

Caution has been our investment theme for 2016. Rebalance, the mantra. All conversations within our strategy and research team centre on these two words.

For mutual funds, it was decided that the key evaluation parameter should be ‘pure play’ to reflect the contemporary theme. The mandate was simple – recommend five pure play large cap funds.

Considering that we have a limited universe of 55 large cap funds, this should have been easy. But we all know that fund managers usually operate with a broader mandate which allows them to calibrate portfolios in a manner that allows them to maximize the return potential. And historically that has worked well for them as well as for investors.

In effect, we had to relook at the universe with this mandate in mind. And only nine schemes qualified – those which invested at least 90% in large caps. Also, these managers needed to have successfully resisted the lure of investing in the other end of the capitalisation spectrum – the promising microcap stocks.

Shortlisting five out of nine pertinent funds was out of the question, we could zero in on only one. The decision was by no means easy or close. Due to the absence of mid-microcaps, the performance boosters of the last few years, this fund did not outshine its peer set despite its significant outperformance relative to the index.

However, this exercise was highly insightful; it forced us to ponder whether the risk the investors were taking was in line their expectations when they invested in, what are loosely termed as, large cap funds. When we dug deeper, we found that 60% of the said large cap fund universe did have some exposure to microcaps since the last five years. Nearly 45% of these had an exposure of (between) 15%-25% to stocks that were not precisely large cap.

Considering that fund managers hold the discretion to allocate the entire corpus to large cap stocks, one can intuitively deduce that fund managers must have seen some serious potential for outperformance in mid, small and microcap segments. In 2012, not many managers could have resisted the compelling lure of these segments when market fundamentals were attractive.

In the same context, if one were to recommend five pure-play midcap funds back in 2012, the task would have been only slightly simpler. Of a universe of 35 funds, 13 funds then had an exposure between 10% – 30% to large cap stocks. Going by the same yardstick (a minimum of 90% exposure to mid, small and micro stocks), only six of these funds would have made the cut. A whopping 65% of the midcap fund universe has had some exposure to giant caps (currently defined as stocks with a market cap of Rs. 86000 cr and above) in the last five years.

It would be unfair to blame fund managers for these choices as they operate within a given mandate, often too broad to define. Over a period of time, investors/advisors get familiar with the funds and start referring these as large cap/midcap, etc. We slowly lose sense of clear classifications until an event strikes and we realize that the outcome is not in line (with what we thought we were buying). It takes a roller coaster ride in the markets like we just experienced that blurred classifications come to fore. It reminds us that investing remains an art that needs to be powered by informed science.