Should investors really want A Large One?

Background: The sub-committee appointed by SEBI for reviewing the eligibility norms for the mutual fund industry have recommended that the minimum net worth should be raised from Rs 10 crore to Rs 50 crore.
SEBI is inviting public comments on this till June 14th and emails can be sent to [email protected]

If there is one lesson that we should have learnt from all the shenanigans of the geniuses in the financial service industry - whether they operate on Dalal Street or on Wall Street - it is this: size is not any indication of safety.

AIG was the largest insurance company in the world.
Lehman, one of the largest Wall Street firms.
Fannie Mae, the largest owner of home loans.
All bust - all rescued by the US government.

UTI was the largest asset management company in India. It went bust.
ICICI was the largest private sector bank in India - and had to be bailed out by the RBI after the Lehman crisis.
The largest real estate companies all pretty much went bust and had to use the money from the public sector banks to be saved.
The mutual funds who issued the most FMP rubbish paper backed by rubbish real estate assets were some of the largest mutual funds in India. And they had to be effectively bailed out by the Reserve Bank of India.

Size, my friends, is not a guarantee of satisfaction.
Not even in the hallowed field of finance that is increasingly being run as a "milk your savings business".

But the sub-committee on mutual fund eligibility norms proclaims loudly" "Mine is a large one".
And brings an envious silence in the room.

So goes the joke about the man ordering a drink in a bar.

The Viagra pill does not do much good for the brain

Look around the magazines and newspapers sprawled across your table. They all have articles on companies that are the worlds largest and the country's largest.

Large must mean "successful".
Therefore, it must be newsworthy.
Therefore, they need to be praised in the press.

Take a look at your portfolio of mutual funds: you probably own many mutual funds launched by the large fund houses.

They may be good fund managers, please don't get me wrong.
But they are certainly large managers.

Just because you are large, it does not mean you are good.
Just because you are small, it does not mean you are bad.

Our email in-box is flooded with all those ads for Viagra.
A power-packed performance is promised.
Do you have a small packet, we are asked?
The guilt of the Indian mind and our inherent shyness, leads us to delete those emails.

But while we may be shy of buying the "largen-ing" stuff those emails offer, the Viagra syndrome seems to have influenced how we go about investing our financial savings. And buying mutual funds.

The distribution channel's persistent effort to make you buy the tried and tested is a source of comfort.

Look at your portfolio of mutual funds again. Looks like you can also claim: mine is a large one.

The illusion of size

There is safety in size.
There is comfort in largeness.

Really?

Well, we have an alternative theory: size is irrelevant in the business of investment management.

We launched the Quantum Long Term Equity Fund in March, 2006.
We were small then. We collected Rs 10.7 crore at launch in March 2006.
We still are small.
We have less than Rs 50 crore in the Quantum Long Term Equity Fund.

But we have our track record: our performance numbers have been fairly consistent and we tend to be in Top 25% (top quartile in ranking jargon, if there are 100 funds we will be in the 1 to 25 range) for many time periods.

I know we have out-performed many funds that are much larger than us. The fact is that they have the size, we have delivered the satisfaction.

When Quantum AMC launched Quantum Long Term Equity Fund in March 2006, the 5 largest equity funds in terms of Assets under Management were:
1) Reliance Equity Fund, Rs 5,820 crore
2) Fidelity Equity Fund, Rs 3,096 crore
3) HDFC Equity Fund, Rs 2,815 crore
4) Franklin India Flexi Cap, Rs 2,283 crore
5) Franklin India Prima Fund, Rs 2,455 crore
And there was Quantum Long Term Equity Fund with Rs 10.9 crore of total AuM. We did not use your money to pay distributors; we did not use your money to run a national advertising campaign.

But how did we, ahem, perform?
Let's say you distributed Rs 100 equally and evenly in each of those 5 Funds - Rs 20 in each Fund.
Well the chart shows that the Quantum Long Term Equity Fund (the blue line) has done pretty well against the largest funds.
The significantly larger size of money with the "5 largest" did not translate into a "performance kicker".

There is more to life than size.

Chart 1: Size does not hinder - or help - performance

You made them large

And note that these funds are "large" because you gave them your money.
Your money.
Had you put your money into Quantum Long Term Equity Fund, we would have been a little larger (and still performed!).

Investors clicked that link in the email which advertised Viagra, which advertised size.
Maybe it is time for you to "unclick" that Viagra link and focus more on other things that really matter - that make a difference to performance.

Things like a disciplined research and investment process.

Or - as we have adopted in Quantum Asset Management Company - the desire to lower your costs by not paying commissions to distributors.

And a desire to launch simple products that make sense for you - the investor - and are not launched merely because it is "fashionable" to launch them. (Uh, anyone remember what happened to the infrastructure funds that were so "hot" a few years ago?)

A detailed analysis of Table 1 above shows that only 1 of the "5 Largest" funds have done better than Quantum Long Term Equity Fund.

The smaller Quantum Long Term Equity Fund has out-performed 4 of the "5 Largest Funds".

"Largeness" is not an indicator of good or bad performance - just as "smallness" does not guarantee a good or bad performance.

One should invest in a fund, not because of size, but because it matches your needs and your ability to take risks.
Invest in a fund that is focused on investment and research processes - and assessment of risks - not because it is large.

Having a Rs 50 crore net worth is not a rationale criterion for setting up a mutual fund business.
It stinks of a desire to create a closed club to pounce on your "share of wallet".

And this recommendation deserves nothing but contempt from SEBI, from AMFI, and from the body of investors who have been misled with myths about who should manage their savings over the past 15 years.

Disclaimer:

Note: This article was first carried on www.equitymaster.com

Above article is authored by Quantum.

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