The mutual fund industry: Waiting for Godot?

Jayant Pai |






A journalist called me up last week asking for my views for a story that she was working on. It dwelt upon the fact that investors were deserting mutual funds in droves as they were disillusioned by a lacklustre market. So much so that the Prime Minister himself was sorry to see the state of the industry and was keen to lend a helping hand. She then asked me what could mutual funds and the Regulator do to ‘attract’ investors once again.

If she was hoping for some revolutionary ideas from my side she must have been disappointed…as I told her that nothing more or new was required. I was neither being defensive nor escapist when I said this… Continue reading

The path to your wallet is through your heart

Which of these sales pitches do you find more appealing?

1. A product which proudly states that had you invested in it since inception you would have earned a Compound Annual Growth Rate (CAGR) of 17.82%, thereby giving you a ‘Real’ return of 9.27%.


2.A product which vividly depicts what it can do for you in the future if you purchase it today. This could involve images of you gifting an expensive cycle to your nine year old grandchild, you beaming with pride at your child’s graduation ceremony, etc.  Continue reading

“Insuring” yourself against misselling

Financial advisors often castigate insurance companies for designing products which are expensive (such as Unit Linked Insurance Plans or ULIPs) and opaque (Traditional Plans such as Endowment and Money Back Plans). This incessant barrage has galvanised the Regulator (IRDA) to make certain policies more “investor” friendly but it is yet unable to plug last-mile loopholes which occur in the form of sharp selling practices.  Continue reading

If consumers are irrational it makes sense for companies to cater to that belief rather than eradicate it

You purchase a brand new mobile for Rs. 10000. The first year you have a free warranty. The salesman offers you a warranty for the second year for Rs. 500. You fall for the bait and buy the second year warranty. What are the chances of your mobile conking off in the second year. May be 1% looking at the track record of all the mobile phones in the last few years. So your warranty is worth only Rs.100. However you believe that the salesman is your best advisor and pay Rs.500 for something which is worth only Rs.100.
However you are in an efficient market and competition will ensure that market forces will drive out these warranties from the market or the warranty prices come down to Rs.100 as more companies start giving warranties. This is how a rational mind will think. Well you are dead wrong if you assume the above to happen.Warranty is a product no one should buy. If humans realized that they would be paying Rs.500 for Rs.100 worth of insurance, they would not buy the insurance. But if they do not realize this, markets cannot and will not reveal the situation.
Competition will not bring the prices down. The salesman plays an important role as a friend and an advisor to sell you something worth Rs.100 for Rs.500. It is difficult for third parties to enter the market efficiently as how can they make money by persuading you not to buy.
When many people are still afraid of flying it was common to see airline flight insurance sold at airports at exorbitant prices. There were no booths on airports selling people advice not to buy such insurance.

Now when the stock markets are up one must be careful. You have brokers, investment bankers, mutual funds, banks in the guise of your best  friends and advisers trying to sell you dreams. When the markets are up more mutual funds and more IPO’s hit the markets. They want to benefit from irrational behavior of investors. However there will be no firms asking you not to be swayed as they cannot benefit from it.

We are in a market where firms compete for the same consumers. Some sell cigarettes and some help you to quit smoking. Some sell fast food while others advise you for diet. If all are rational human beings (econs) then there is no argument which competing interest will win. However the problem is that consumers are humans and make irrational decisions leading to bad choices. Here is how firms benefit out of their irrational behavior. In stock markets we have opposing interests like day traders v/s long term investors and stock tips v/s value investors. Irrational investors add to the chaos making it easy for firms to benefit from their irrationality. Your business news channel has become your stock advisor, the banks salesman is your financial advisor,and your friendly neighbor is your portfolio manager.

At present stock markets are going through great volatility. It is important that investors keep their cool and behave rationally. There are hawks waiting to make money out of you. Remember there are no short cuts in life. Ponder on the following questions: Why do IPO’s not come in bear markets?  Why do we not get stocks tips daily on our mobile in bear markets? Why don’t FIIs buy in bear markets when the prices are low? Why do experts predict markets higher when the stocks are going up? How does one know that the Sensex will touch 25000?

My friend you are in a bull market. You are more likely to turn irrational and make big money mistakes. That’s the reason you got to be cool and not be carried away by the noise of the markets.

Where the package is the value, ULIPs vs. Mutual Funds

There are many products in the world where the label or the packaging is what imparts value. The product in itself constitutes a fraction of the overall value derived by the consumer.

Take for example a Rolex watch, a Louis Vitton bag or an expensive bottle of wine. It is what the consumer percieves that is important as opposed to what is rational. If consumers were rational, they would probably be willing to pay only a fraction of the current price.

The case of Unit Linked Insurance Plans (ULIPs) vs. Mutual Funds is similar. While the former is an expensive vehicle to invest through, the latter is the best value rationally. However ironically it may be the case that investors derive more “satisfaction” in ULIPs as compared to Mutual Funds. The Mutual Funds do not promise a child’s education or a comfortable retirement or the highest NAV. Also due to the fact that most funds are open ended and periodically ranked according to short term performance, it encourages short term behaviour in distributors and investors. Hence the entire focus of investors is diverted from long term investment returns from Mutual Funds to short term volatility of the markets.

What is probably needed in Mutual Funds is a move towards interval schemes with Systematic Investment Plans and a defined investment horizon. These schemes would have an asset allocation which would be determined based on the target retirement date or the target education goals (the defined investment horizon). The investor would be assured that a systematic asset allocation will take away undue volatility and help in meeting life stage financial goals and at the same time benefit from the low cost structure of Mutual Funds.

It is probably a time for Mutual Funds and the regulators to understand the art of packaging!