Vivek Kaul

Mumbai: Sanjoy Mitra, a fund manager with a leading mutual fund, was getting ready to go to office, but couldn’t locate his tie.Why on the earth did he have to wear a tie in the first place?

He hadn’t found an answer even after a decade in the corporate sector.

Right now, though, there was a bigger problem at hand. The diversified equity mutual fund scheme he managed had performed exceptionally well in the last one year, despite the market downturn. Now, this had led to retail investors and corporates pouring more money into the scheme. He had to find avenues to invest all that money in.

Mitra chuckled at the irony. Back in late 2002 and early 2003,when the market was ready to take off, there were hardly any investment coming into the scheme. He had so many ideas then, but so little money to execute them. And now, when he had the money, those ideas were really not relevant anymore.

He remembered reading in a book by Debashis Basu, Face Value, “Retail investors always hand over money to fund managers when the market is going up, making it harder for the latter to perform.”

When a mutual fund scheme does well, investors pour more money into it. But, as assets under management increase, a fund manager is left with fewer options to invest in.

If he decides to retain the money as cash, and the stock market keeps going up, the returns go down. If he decides to invest in a stock, which he already owns and which would have probably gone up by then, his returns are again less. When he invests in such stocks, there might be a danger that they might become overvalued.The last option is to buy stocks which he would not have bought in the first place.

Further, as more money comes into the scheme, executing larger trades becomes difficult, leading to higher expenses. As Jason Zweig points out in the commentary to Benjamin Graham’s all time investment classic, The Intelligent Investor, “It often costs more to trade costs in very large blocks than in small ones; with fewer buyers and sellers, it’s harder to make a match.”

“As a fund grows, the fees become more lucrative,” making its managers reluctant to rock the boat, writes Zweig. The very risk that managers took to generate their initial high returns could now drive the investors away - and jeopardise all that fee income. So the biggest funds resemble a herd of identical and overfed sheep, all moving in sluggish lockstep, all saying “at the same time.”

“Performance is benchmarked to an index, the mass market behaviour. To be wrong, when everyone else is wrong is not such a bad thing. Hence everyone focuses on the same numbers, similar stocks, surfing the latest fad,” wrote Basu.

Mitra knew all this by heart. But, this was not what he was really worried about. A rival mutual fund, seeing his performance over the last one year, had given a great offer to switch over.

The example is hypothetical

Source : DNA