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Advisor Speak 1st July 2013
The real problem with equity funds lies in the way we deliver them
Surendra Kumar Bagaria, Kolkata (Mentor - ASK Circle)


Bagaria ji, as the mentor of ASK Circle, is a rich repository of wisdom and practical insights and has a razor sharp focus on only doing what is right for the investor. Wealth Forum asked him what it will take to actually help investors get a positive equity investing experience. For far too long, the MF industry has talked about its long term wealth creation track record, while only a tiny fraction of equity investors have actually experienced this. What will it take for investors to actually benefit from equity investing? What should we do differently? Bagaria ji has very clear thoughts on what we need to do : we need to worry less about the product, and focus more on how we collectively deliver it to the investor.

There are perhaps more dissatisfied equity fund investors today than satisfied ones. This dissatisfaction is keeping them away from equity funds, as their experience has not been good. On the other hand, as advisors, we keep worrying that investors are significantly underweight in equity, which is unhealthy for the long term well being of their portfolios.

The crux of the problem is that investors are blaming the product called equity funds, whereas in my view, the real problem lies not in the product, but the manner in which it is delivered. We need to get this distinction clear, if we are to make a real effort to solve the problem. My purpose here is not to point fingers on what went wrong in the past and who is responsible for that - everybody has made their share of mistakes. The point is how can we learn from the past to ensure that going forward, we do the right things and help investors get a better investing experience from equity funds.

Do we disagree with any of these 5 points?

  1. India is a growing economy

  2. In a growing economy, corporate profits will grow - sometimes fast, sometimes slowly, based on business cycles. But we are unlikely to see several years of profits shrinking, year on year

  3. Stock markets ultimately reflect corporate earnings growth - sometimes it is amplified (in bull markets) and sometimes it is discounted (in bear phases). Despite these alternate bouts of amplifying and discounting, the long term trend line of stock markets mirrors the long term trend line of corporate profits

  4. This long term trend line has been historically delivered real returns - returns that beat inflation, net of tax

  5. We have in our industry equity funds which have track records of capturing these returns - funds that have demonstrated track records of staying in line or beating market returns over the long term. Every fund goes through its phases of out and underperforming the market, but over long periods of time, we have enough evidence of equity funds ability to capture at least market returns, and often better than that.

If we accept all these 5 statements, we must accept that the fault lies not in the product but in our collective ability to deliver the returns from this product to the investor. Real returns are being generated by the product called equity funds - but we are unable to deliver it to our investors. The focus of our attention should therefore go towards where we are going wrong in the delivery aspect.

Where are we going wrong in the delivery of this product ?

1. Uninformed investors

I follow a basic principle : I do not sell anything I don't understand. And I do not sell until I ensure that my client understands it. These 5 points that I have listed above must be explained with adequate data, so that investors understand what they are getting into and why they are getting into it.

2. Wrong objectives

Bulk of equity fund sales are made to investors who come in with speculative expectations and not for long term wealth creation. We must completely discourage all forms of speculation in equity funds and encourage investors to come in for the right reasons - or don't invest otherwise.

3. Target and incentive based sales

When AMCs come up with promotional campaigns which offer target based incentives, many distributors knowingly or unknowingly mis-sell. This must be stopped at both ends - AMCs must promote their products on features and track record and not on incentives. Distributors likewise must sell products on the basis of conviction in the product rather than incentive on the product

4. Trading calls

When we all clearly recognise that equities are best held for the long term, why do fund managers confuse distributors with trading calls and opportunistic strategies? Trading calls reinforce the speculative side of equity markets - which is best left to direct equity trading. Why do we want to do anything that encourages speculative tendencies in equity funds? More importantly, who is giving an exit call? Without a proper exit call, even the best trading buys turn out to be disasters.

5. Complex products

We have hardly even done justice to delivering plain vanilla diversified equity funds to retail investors. Why rush with more complex funds like thematic funds and sector funds? AMCs must focus their energies on promoting plain vanilla diversified funds and stay clear of promoting thematic products in the retail world. If you think about it, thematic products again play into the speculative element in an investor's mind - make more money in this theme in the short run, as compared to what you can make in the market. Who is around to give an exit call from a theme? Will fund managers do this? If not, please don't give a buy call - when you can't give an exit call.

Why do clients exit and how can we help reduce premature exits?

Even if we do the right thing in terms of helping investors buy equity funds with the right objectives and knowledge, there can be many reasons for premature exit. Three of the main ones include :

1. Need the money

In my experience, 10% of redemptions are to meet unexpected requirement of funds to meet certain obligations. There's nothing we can do about it, other than help the client get the money as quickly as possible, to meet the requirements for which he is redeeming. In this context, a move to abolish exit loads will empower investors significantly. Let there be no manner of pressure to stay invested - let investors stay invested for the right reasons and not the wrong reasons.

2. Fear of volatility

This is the biggest reason for premature redemptions. If investors came in for speculative reasons, obviously they will get out when that speculative venture did not yield immediate results. If investors are uninformed about equity markets - are not clear of the 5 basic points on equity, they will want to exit at the first sign of volatility- because they were not well informed at the time of purchase. A lot of panic redemptions can be avoided if we focus on getting investors in - the right way.

But, even if investors come in with a long term objective, we do see some of them getting nervous with market volatility and wanting to redeem their investments, out of fear of further losses. It is here that fund houses must increasingly focus on building volatility control mechanisms in their funds. Products like dynamic P/E funds - which regulate the allocation into equity based on market P/E levels or products like the I-Pru VAP are good examples in this context.

3. Churn

The third reason for exit is because somebody else - other than the investor - benefits from the investor's money moving out of one fund and into another one. The best way to tackle this menace is to put an end to all forms of upfront commissions. Until you have a situation where first year commissions are much higher than subsequent years, you have an in-built mechanism that promotes churn. Fund houses must get out of this payment structure and adopt a full trail commission model. If you want to incentivise new distributors who do not have sufficient AuM, please offer them retainers or marketing support or any other form of support that is not linked to individual products. When it is linked to sales, you are not encouraging best practices - you are actually encouraging bad practices.

To conclude

If we distributors are serious about ensuring that all our investors get an adequate allocation to equity which can help them beat inflation in the long term, we need to just do two things :

  1. Focus on empowering and enlightening your clients - and only then on sell to them.

  2. Sell only what you think is right for your client and not what suits any AMC's sales strategies

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