Mystery of Missing Returns

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Warm Greetings from PenguWIN:

            I wanted to share this message with you before you might observe and become anxious. A couple of our investors have noticed it and requested for clarification. It has no effect on the value of the fund but portrays the performance in poor light. The details might be slightly technical (no impact to you) which is the reason why I was holding this message but thought that this note be shared when investors started asking for the clarification.   

The Categorization and Rationalization of Mutual Fund Schemes was initiated by SEBI, last year, to ensure that the schemes are clearly distinct in terms of investment strategy, asset allocation, uniformity in characteristics of similar type of schemes to help investors take informed decisions.

SEBI had discussed this with the MFAC (Mutual Fund Advisory Committee) and as a result of deliberations, the committee proposed the following changes in Oct 2017 to be implemented by the fund houses by June 2018.

  • Group Mutual Fund Schemes, into 5 groups including Equity (investing in stock), Debt (investing in overnight securities with 1-day maturity, money market, debt for varying durations), Hybrid (mix of stocks and debt instruments – typical balanced funds), Solution Oriented (Retirement, Children) and others (Index Funds, Exchange Traded Funds, Fund of Funds, International Funds
  • Rationalization of the Market Cap (product of no. of shares and prevailing price) definition by ranking them in descending order:   
    • Top 100 companies in terms of market cap to be referred as Large Cap
    • Companies with market cap from 101 to 250 market cap to be referred as Mid Cap
    • Companies from 251 and above in terms of market cap to be referred as Small Cap

 

This exercise resulted in Mutual Funds to adopt a uniform definition of Market Cap which was different for each fund house earlier as there were no standard definitions, like a small cap company as per Fund house A referred as mid cap company by Fund house B. The exercise also limited fund houses to have only 1 scheme per category, specifically in Equity, Debt and Hybrid resulting in merger of funds, changes to attributes and nomenclature of funds. In the past several fund houses had more than 1 Large Cap, Mid Cap, Balanced Fund and so on.  

As part of the merger of 2 funds into a new category, the assets from each fund had to be transferred into a new pool and either 1 of the exiting fund managers or a new fund manager had to be designated as the fund manager for the merged entity.

For better understanding, I am taking the case of HDFC Balanced fund which is one of the top performers in the erstwhile balanced category and a significant number of our investors own this fund. HDFC MF also had HDFC Prudence, which is also a well-known name, managed by Prashant Jain, though the risk profile is higher. In this instance, HDFC Balanced fund and Premier Multi-Cap fund were merged to form HDFC Hybrid Equity fund.  As part of the merger, the value of holdings in HDFC Balanced and the invested amount has been presented in a way that all gains accrued by the fund is lost (refer to the attached picture that displays the actual transactions for an investor). The amount obtained by moving out of the old fund is portrayed as the cost of new fund (Hybrid Equity). As a result, the investment amount in the portfolio is bumped up to that extent resulting in poor returns.

In this case the actual investment made by investor was Rs. 3,61,854 (accumulated 3230 units @ 112 Rs.) and the amount received during exit from old fund was Rs. 4,75,010 which is a gain of Rs. 1,13,156/-. However, the current transaction shows a loss of Rs. 9,575/-

The only sure thing about luck is that it will change - Bret Harte 

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