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| October 14, 2016 |
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Impact 
Many investors make the mistake of chasing returns. The basic premise is schemes that have done well till now will continue to do well even inthe future. Over the last two years, mid and Small cap stocks have outperformed their largecap peers by far. In fact, many investors expect that good fortune for smaller companies will continue.
Smaller companies dominate...
Data as on October 10, 2016
(Source BSE, PersonalFN Research)
The ugly side of mid and small cap funds...
A few mutual fund schemes, focused on investing in smaller companies, have done exceedingly well in the past. No wonder, they are attracting unprecedented inflows these days and their Assets Under Management (AUM) have grown by leaps and bounds over last 2-3 years. Unfortunately, not many investors recognise the downsides of such aninvestment approach.
If you just look at the performance of the fund in the immediate past and its star rating, you might end up ignoring crucial information about it. Before you invest in a mid and small cap fund, you need to run a check on a few more aspects, for example, how liquid (or illiquid) is the fund's portfolio. In simple words, the liquidity profile of a portfolio of a fund indicates how quickly the fund manager can raise cash, selling equity holdings. You might wonder why this should be a major consideration?
Well, everything appears in shipshape when bulls are out on Dalal Street but when the markets are in the tight grip of bears, Net Asset Values (NAV) of many funds focused on mid and small caps sink. Under this falling market scenario, investors often make a quick exit. During this phase, the pressure mounts on mutual fund schemes and it becomes increasingly difficult for them to raise cash. Even worse, investors' interest in mid and small cap stocks tank, which adds to the woes of fund houses.
As reported by the Economic Times dated October 10, 2016, based on the liquidity scores assigned by Crisil, liquidity profile of mid and small cap funds has deteriorated over last 1 year. The average liquidity score of mid and small cap funds has risen from 9.01 to 11.91. This means the average time that a scheme might take to liquidate the entire portfolio has gone up from 9 days to 12 days overthe last 1 year.
However, what's worrisome is that the liquidity score of some prominent and popular funds (that have received massive inflows) has been as high as 25. You can't entirely blame the fund managers for this. As the AUM of these schemes grows, it becomes increasingly difficult for them to identify quality stocks.
Consider this real life example...
A very popular micro-cap fund that manages Rs 3,806 crore (as on September 30, 2016) has invested 2.38% of its assets in a listed company—'Thyrocare Technologies'. In other words, the worth of a scheme's investments in the enterprise is a little over Rs 90 crore as on September 30, 2016. Now consider the total value of traded shares of the company on the National Stock Exchange as on October 10, 2016. At Rs 1.58 crore (Source NSE), it appears abysmally low. What's more, the total free-float market cap of the company as on October 10, 2016, was Rs 736.33 crore (Source: NSE). Free-float market cap reflects the worth of shares that are available for trading at any point in time. Essentially, it doesn't include the stocks lying with the promoter. Coming back to the point, the said micro-cap fund has a substantial holding in the company considering its a free-float market cap. Although, these figures change every minute, the holdings of the fund in a company accountfor more than 10% of the free-float market cap of the company.
The trouble will arise when the fund faces the redemption pressure, in the case of markets falling substantially in the future. The fund will then have two options—first, sell stocks that are liquid (ignoring their attractiveness) or the second option would be to sell weaker and illiquid assets. If a fund chooses to exercise the first alternative, it will end up holding a poor quality portfolio of illiquid assets. Alternatively, if it opts for popping off weak and illiquid stocks, it may incur heavy losses. Imagine, what might happen if the fund in discussion tries selling all its holdings in 'Thyrocare Technologies' under poor market conditions. If the volumes fail to improve from the current levels, the fund might take months to liquidate its entire holdings in the company.
Why blame only a fund or a company?
This is not just about a company or a mutual fund scheme, there are dozens of such instances. Underlying companies may have sound fundamentals, and even the fund managers might have also identified the true potential of these enterprises. But, the lack of liquidity will always be a culprit when there's a selling pressure in the market. To ward off such possibilities, fund managers of such schemes cut their exposure to smaller companies, replacing them with the larger ones. Although, this strategy helps to provide stability to the portfolio, often, it results in the underperformance of the scheme in the future, especially when smaller companies keep buzzing and large cap stocks cool off.
What should be your strategy?
As an investor, you can hardly have any control over any of the happenings discussed above. This is why PersonalFN believes in carefully analysing your risk appetite before investing in mutual funds. Those with a slightly conservative approach would do better if they avoid investing in small and midcap focused funds, especially when valuations look expensive, corporates record a lower growth in their earnings and markets appear to be heading for a correction.
Those who are unsure about which mutual fund schemes to invest in may try the unbiased mutual fund research services offered by PersonalFN. Along with quantitative parameters such as performance, PersonalFN also considers qualitative parameters such as portfolio characteristics while analysing mutual fund schemes
Do you think mid and small cap funds with huge AUM are at a disadvantage? Share your views here Facebook | Twitter
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Impact
The Securities and Exchange Board of India (SEBI) has decided to tighten the bolts on distributors of financial products. In a new development, the capital market regulator has made its intent clear, a person or a corporate entity can either be a distributor or an advisor, it can't earn profit /commission as both.
About 3 years ago, the capital market regulator introduced SEBI (Investment Advisers) Regulations, 2013to encourage ethical practices and accountability in the area of financial advisory. However fast forward 3 years, there are only about 500 SEBI registered financial advisors. The reason being, SEBI offered exemptions to many individuals and corporate entities. For example, independent mutual fund advisors who have attended a minimum qualification benchmark as prescribed by SEBI are allowed to provide advice on mutual funds. But, now the new proposal which is open for the public comments until November 04, 2016, suggests that IFAs (Independent Financial Advisors) will be called mutual fund distributors unless they register themselves as Registered Investment Advisors (RIAs). Furthermore, SEBI also intends to get stock brokers, portfolio managers, Chartered Accountants and Company Secretaries under the scope of SEBI (Investment Advisers) Regulations, 2013, if they are offering any investment advice incidental to their profession. All of them were excluded earlier.
For example, now a chartered accountant helping you in tax planning by suggesting financial products will have to register himself as an investment advisor.
Moreover, investment advisors are required to work only for fees and shouldn't have any claim on commission earned through the distribution of financial products. However, they will be allowed to earn trail commissions on products they have already distributed.
What's more? Operations of banks and new robo advisory platforms offering both, investment consulting as well as distribution services, will be affected negatively. They too will have to register themselves as investment advisors and would be subject to more stringent audits including those of their algorithms, in the case of robo advisors.
The regulator would provide them a 3-year transition time to individuals as well as corporate entities such as banks. Companies will have to hive off their consulting business in a separate subsidiary within 3 years of norms becoming applicable. Distributors can either upgrade themselves to a higher rank or will have to stop calling themselves advisors.
While the intent of SEBI is to protect investors' interest, which it should, the proposed regulations might make it tough for the industry players to run their businesses. There is a need to open up the debate and listen to both sides without going with preconceived notions.
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Impact
From the beginning of the Financial Year (FY) 2016-17, equity markets have rallied ferociously. CNX Nifty has generated 12.8% returns, while CNX 500 has yielded 16.8% so far. As per the NSDL record Foreign Institutional Investors (FIIs)have poured in Rs 48,243 into the India markets. Domestic Institutional Investors (DIIs) have also maintained their bullish stance on Indian markets. At Rs 16.11 lakh crore, primarily led by incremental investments in equity schemes, Assets Under Management (AUM) of mutual fund houses touched an all-time high in the Q2, FY 2016-17. While this all may sound hunky dory, the fact is, equity markets are losing steam in India. Key market indices are struggling now. Nifty 50 has been finding it difficult to inch higher. And in the absence of robust growth in corporate earnings, markets now look dangerously poised.
Expensive market valuation…
Data as on October 07, 2016
(Source: NSE, PersonalFN Research)
The chart above makes it clear that broader markets are doing a lot better than the front-line stocks, but this enthusiasm is unfounded as valuations in the midcap space have become extremely expensive . Those in the largecap segment are not cheap either. Optimism is rising, indices are rising, investments are rising, but earnings have stayed persistently low. Can Q2 be an exception?
Going by the broader market estimates and the recent account of developments, healthy growth in corporate profit is still a pipedream. The rally so far has happened on account of two factors—ample liquidity in the global system and the expectation of a sustained recovery in economic growth. Liquidity still remains very strong, despite the odds remaining in favour of Federal Reserve (Fed) raising interest rates; but valuations are likely to become a drag unless corporate earnings grow now.
To read more about this story and Personal FN's views over it, please click here.
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Impact
After rallying for the most part of 2016, lately gold prices are going through the doldrums . They touched a high of Rs 31,728 for every 10 grams on July 07, 2016; but fell 6.4% from those levels by October 07, 2016. A combination of international factors and a few domestic factors such as Shraddh (A period when buying gold is considered inauspicious) pushed the gold prices lower.
Got to get bolder?
Data as on October 07, 2016
(Source: ACE MF, PersonalFN Research)
In the international market, the strength of US$ decides the prospects of gold. At the moment, there is consensus on the Federal Reserve (Fed) being likely to hike rates in the U.S. sooner rather than later. This is further supported by the improving conditions in the U.S. job market. The unemployment rate has dropped to a 43-year low in the last week. Rising interest rates push the US$ higher and discourage the gold prices.
But as Indians flock their way to jewellery shops, in search of good fortunes, this Dussehra and Diwali, demand for gold is likely to perk up. Festive season followed by the wedding season may drive the demand even higher. Many large participants in the gold market believe that the falling gold prices may provide an impetus to aggressive buying. This optimism is endorsed by the World Gold Council as well. It recently stated that "a shift in monetary policy need not signal lower gold prices. The price dip will likely result in physical demand from consumers, long term investors and central banks." Adding to this, it said, "the broader market environment of ongoing low and negative interest rates, coupled with continuing political, economic, and policy uncertainty remains unchanged, and are generally positive for gold."
To read more about this story and Personal FN's views over it, please click here.
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The contribution of the state of Gujarat might be significant when it comes to the economic progress of the nation, but when it comes to the legitimacy of insurance claims, the state fares extremely poorly. Insurance companies pay an additional 30% to 40% on claims than what they collect as premiums. In the rest of the country, the claim ratio is 60%-70%. In other words, Gujarat reports about 100% higher claims as compared to those reported elsewhere. As a prudential step, even insurance companies have now started charging close to 15% higher premium in Gujarat market.
PersonalFN is of the view that, instances of fraudulent claims are dangerous for the industry as these affect the underwriting decisions, for every one especially genuine insurance buyers. Such practices must be discouraged at all levels.
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Free-Float Methodology: Free-float methodology is a method by which the market capitalization of an index's underlying companies is calculated. Free-float methodology market capitalization is calculated by taking the equity's price and multiplying it by the number of shares readily available in the market. Instead of using all of the active and inactive shares, as with the full-market capitalization method, the free-float method excludes locked-in shares such as those held by insiders, promoters and governments.
(Source: Investopedia)
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Quote: "To be an investor you must be a believer in a better tomorrow"- Benjamin Graham
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