There were some data errors in the article, which have been corrected now. We had mentioned that 56 schemes bailed out I-Sec (these include two merged schemes so the number is 54). The number of schemes which exited is also far fewer, others are still holding on to their losses. This does not negate the main two points of articles: that fund houses clearly stepped in bail out the I-Sec issue and that several of them exited immediately. We will upload a corrected list soon. We apologise for the error.
Over the past few weeks, the mutual fund (MF) business has been hit by many changes. The market regulator, Securities & Exchange Board of India (SEBI) has forced fund houses to look less like fast-moving consumer goods (FMCG) companies, given the frequency with which they were launching new products and product variants. Fund houses have been forced to straightjacket their products menu. They have to have just a few categories of each variant and just one product in each category. The strategy of making new scheme offers, to make suckers of retail investors, in a bull market is, perhaps, over.
But there is one thing that is still hidden from investors -- the hypocrisy of MFs lecturing investors about holding for the long term and churning stocks every month like a short-term trader. Also, the old practice of financial houses helping each other out at a time of failing initial public offering (IPOs) from the 1990s is alive and kicking. These two combined in a scandalous manner in the case of ICICI Securities (I-Sec) IPO. Here are some startling facts.
The Bailout…
In March 2018, ICICI Securities (I-Sec) priced its IPO at Rs520 per share. The timing was terrible and the price exorbitant. The market was falling and there was no appetite for I-Sec shares at such a high price. The issue was barely subscribed 29% on the first day and only 36% by the second day. It was about to devolve. The book running lead managers were BofA Merrill Lynch, Citigroup, CLSA India, Edelweiss Financial Services, IIFL Holdings and SBI Capital Markets.
No problem. The financial community is closely-knit and accommodative, especially when it comes to bailing each other out with retail investors’ money. So, as many as 56 schemes, across 15 fund houses, jumped in to help I-Sec, buying 3.06 crore of its shares, when it was absolutely clear from the market trends that there was no interest for this high-priced IPO.
The lion’s share of the contribution, of course, came from I-Sec’s group company, ICICI Prudential Mutual Fund, which picked up 1.23 crore shares. This unusual move attracted SEBI’s attention. It has ‘advised’ ICICI Pru to compensate the five schemes that bought the shares, especially since the stock has tanked after the issue. ICICI Pru was not alone in the bailout game; but it was a glaring case of conflict of interest and so SEBI acted on it. Other fund houses that bailed out the I-Sec IPO were: Aditya Birla Sun Life, Axis, DSP BlackRock, Edelweiss, HDFC, IDFC, Kotak, L&T, Reliance, SBI, Sundaram and UTI.
Of course, mutual funds, the custodians of retail shareholders’ money, would argue that they bought the shares because they found tremendous value in the I-Sec IPO at the offer price. So, they couldn’t wait until the issue got listed, presumably because it was not going to be available at a lower price. That is, probably, why they just had to jump in to buy this great stock at the IPO price. This would be the logical scenario, because you know how fund companies claim they are all very professional. There is no scope for any unethical behaviour or conflict of interest. They have top-notch research analysts and experienced fund managers. There is enough of paperwork to support their actions -- investment committees, checks & balances and, of course, oversight by trustees -- all to protect retail investors from wrongdoing by fund managers. Let me show you how in the I-Sec case, all this turned out to be complete nonsense, as the actions of several top fund houses have decisively proved,.
…At Your Cost
The fund companies (who now manage lakhs of crores of money entrusted to them by lakhs of retail investors), that bought I-Sec shares were clearly bailing it out because they had no interest in holding such an expensive share for long. It was not an investment for them; they just used retail investors’ money to help one of their ilk. And so, after about a month or so, they started selling. According to the data from Mutual Funds India database, several of the 56 schemes that bailed out I-Sec completely exited the stock, at a massive loss. The stock opened far below its offer price on listing, at Rs435, and dropped further to Rs330 by the end of June. Depending on the exit, these schemes, run by the finest investment minds with great boards of trustees, made a huge loss on what was disastrous short-term trade.
Don’t miss the monumental irony here. Mutual funds, as you know, relentlessly sermonise that you should invest for the long term and tune out short-term fluctuations. Most fund houses train their distributors to show you how their schemes, held for many years, can fetch you very high returns, underlining the importance of buy&hold.
The Dirty Little Secret
And, yet, the ‘churn’, politely called portfolio turnover ratio, among MF schemes is high. Some of them are just too trigger-happy churning your portfolio several times a year. Some even buy and sell the same stocks erratically for no reason except to chase momentum. Here are the top-5 churners of 2017-18.
The pitch of fund houses is that picking stocks is a job that needs long years of knowledge and expertise and MF managers are supposed to be experts in that game. They are also handsomely rewarded for their knowledge and the trust that people repose in them. Unlike millions of uninformed and emotional individual investors who, reacting to greed, buy high and, then, reacting to fear, sell low, fund managers are supposed to know what to buy and when. However, in real life, fund managers have been known to chase momentum, buy glamour stocks at high valuations, buy at the wrong time and sell at the wrong time. The worst, of course, is that, often, their behaviour is like clueless short-term traders and not thoughtful long-term investors. And, as in the case of I-Sec, there are collusive deals to help one another.
How To Fix It?
All SEBI needs to do is focus on the exact pressure point of funds. There are two of them -- trustees and management fees of fund companies -- from where high salaries and the value of stock options flow. First of all, SEBI needs to speak to the trustees of these fund houses about this specific episode and put them on notice. For future shenanigans, make trustees personally liable. Second, a lot of things will fall in place if SEBI applies a simple formula of higher the churning, lower the fees. There is simply no downside to penalising higher portfolio turnover since MFs themselves profess a long-term philosophy of buy&hold. Fund companies churn stocks for higher returns. And if a fund house is skilled in churning profitably even after higher fees, it will show better returns and attract more assets under management and higher amount of fees in absolute terms. But take it from me, nobody will churn and risk lower fees. They have been happily churning all these years because it was all at your expense. They will start behaving themselves, if their own earnings are at risk.
They will continue the game. It's better to confiscate the bad money?