Introduction:
Equity Mutual fund seems to have become a great investment option in recent times. In-fact mutual fund companies (With their famous tag line “Mutual Fund Sahi Hai”) are leaving no stone unturned to bring the common man into the wild market commonly known as the Share market. But can mutual funds outperform the market and get us the desired return or is there a catch to it? Are these investments worth the hype?
With this article, I shall help you to understand how this mutual fund works and how they suffer from a curse, a paralysis that offsets all of the mutual fund’s major advantages over a long period of time. And I will try to support my points with some recent case study, past figures, logic, and facts. Let us begin with the basics.
What is Mutual Fund and how it works?
A Mutual fund is a concept where mutual fund company is a fund managing company that pools the funds from the small like-minded investor (known as Unitholder) and then invests their pooled funds into the stock market. And as the value of the investment in the stock market increases over the period of time, the value of Investment of unitholder also grows.
Example: Suppose there are 3 people A, B, and C. With a capital of ₹10,000 each. And all of them want to get invested in Share Market. But, since they are new to this whole open market investment, they reach out to a mutual fund company for a ‘safe investment’.
Now, the mutual fund company shall collect the unitholder’s funds and form capital for themselves (Capital of ₹ 30,000) and will invest this capital into the stock market on investor’s (i.e.., A, B and C’s) behalf (Securities on which mutual funds have invested is known as a portfolio). In return, Mutual fund companies shall charge some small commission on the funds as their fees for managing investor’s funds. And as the portfolio of the mutual fund grows in the stock market, the unit holder’s value of investment also multiplies.
Ideal Situation: How it should be or at least how it is usually portrayed.
All the mutual funds in India are managed by well-educated B-School Graduates, Chartered Accountants, PGs with finance diplomas and degrees, Vastly experienced fund managers, and share market veterans. These analysts are usually the best in their fields and their qualifications couldn’t be challenged.
They are well equipped with the latest market data and analytics to make the right investments in great companies. Therefore, ideally, if they are hired to manage our funds then they ought to be in a great position to give us a great return. (And of course, this basic assurance that our funds are managed by great people is what usually attracts people to invest their money with the mutual funds).
But now let us check what rate of returns the top mutual fund schemes in India have yielded for their unitholders in the past 5 years.
Real Situation: What it actually is.
Here I am consolidating the data showing returns (in %age) of top 30 large-cap mutual fund schemes over 6 months, 1 Year, 2 Year, 3 Year, and 5 Year period.
| Scheme Name | 6M | 1Y | 2Y | 3Y | 5Y |
| Canara Robeco Bluechip Equity Fund – Regular Plan – Growth Large Cap Fund | -9% | -1% | 4% | 6% | 8% |
| JM Large Cap Fund – Growth Large Cap Fund | -4% | -2% | 1% | 2% | 3% |
| Axis Bluechip Fund – Growth Large Cap Fund | -12% | -4% | 3% | 8% | 8% |
| BNP Paribas Large Cap Fund – Growth Large Cap Fund | -12% | -5% | 2% | 2% | 5% |
| IDBI India Top 100 Equity Fund – Growth Large Cap Fund | -13% | -6% | -2% | -1% | 3% |
| LIC MF Large Cap Fund – Growth Large Cap Fund | -15% | -8% | 0% | 2% | 4% |
| Baroda Large Cap Fund – Plan A – Growth Large Cap Fund | -13% | -8% | -1% | 0% | 3% |
| Edelweiss Large Cap Fund – Growth Large Cap Fund | -14% | -10% | -2% | 3% | 5% |
| IDFC Large Cap – Regular Plan – Growth Large Cap Fund | -12% | -7% | -2% | 2% | 5% |
| UTI Master share Unit Scheme – Growth Large Cap Fund | -13% | -8% | -2% | 2% | 5% |
| Invesco India Large cap Fund – Growth Large Cap Fund | -13% | -8% | -2% | 2% | 5% |
| Kotak Blue chip Fund – Growth Large Cap Fund | -15% | -8% | -1% | 1% | 5% |
| HSBC Large Cap Equity Fund – Growth Large Cap Fund | -15% | -8% | -2% | 1% | 6% |
| Mirae Asset Large Cap Fund – Regular – Growth Large Cap Fund | -16% | -10% | -1% | 2% | 8% |
| ICICI Prudential Blue chip Fund – Growth Large Cap Fund | -15% | -11% | -3% | 2% | 6% |
| L&T India Large Cap Fund – Growth Large Cap Fund | -16% | -11% | -2% | 1% | 4% |
| PGIM India Large Cap Fund – Growth Large Cap Fund | -17% | -12% | -3% | 0% | 4% |
| Taurus Large cap Equity Fund – Growth Large Cap Fund | -17% | -13% | -5% | -3% | 1% |
| India bulls Blue chip Fund – Existing Plan – Growth Large Cap Fund | -19% | -14% | -4% | 0% | 5% |
| Essel Large Cap Equity Fund – Growth Large Cap Fund | -15% | -11% | -4% | -2% | 5% |
| SBI Blue Chip Fund – Growth Large Cap Fund | -16% | -12% | -4% | 0% | 5% |
| DSP Top 100 Equity Fund – Regular Plan – Growth Large Cap Fund | -19% | -12% | -4% | -1% | 4% |
| Aditya Birla Sun Life Frontline Equity Fund – Regular Plan – Growth Large Cap Fund | -16% | -12% | -5% | -1% | 4% |
| Tata Large Cap Fund – Regular Plan – Growth Large Cap Fund | -18% | -15% | -4% | -1% | 3% |
| Franklin India Blue chip Fund – Growth Large Cap Fund | -13% | -11% | -5% | -1% | 3% |
| Nippon India Large Cap Fund – Growth Large Cap Fund | -22% | -20% | -7% | -2% | 3% |
| HDFC Top 100 Fund – Growth Large Cap Fund | -21% | -22% | -5% | -2% | 4% |
| Mahindra Manulife Large Cap Pragati Yojana – Regular Plan – Growth Large Cap Fund | -16% | -9% | – | – | – |
| Union Large cap Fund – Growth Large Cap Fund | -15% | -10% | -3% | -1% | – |
*Data Source: Moneycontrol.com
I think now I am ready to state my point. Not even a Single mutual fund scheme out of the 30 top large-cap mutual fund schemes was able to give a positive return to their unit holder if they got invested in the last one year. And only 3 funds gave a return higher than 6% (Absolute Return) to their unitholders who were invested for the last 5 years.
I mean if you had invested your funds in the Public Provident Fund you would have earned an annual return of 7-8% with some sound sleep along with tax benefits.
But why is that? Are these fund houses suffering from some paralysis? Or is it just due to the recent market crash? Answers to these questions are given in the below paras.
Why this tragedy? Is there an Achilles heel on these great fund houses?
My answer is YES. These fund houses not only in India but in-fact all over the world are paralyzed by the ‘fear of bear market’. (Definition of Bear Market: In the words of Peter Lynch, “When a Stock Index falls over 25% in the market, it is termed as a bear market”).
‘Fear of bear market’ is nothing but a situation where the unitholder panics in the fall of the market and anticipates that the market will fall even worse in the future. And this anticipation forces them to make an irrational decision making and leads them to redeem their units in mutual funds so that they could save any further erosion of their capital. And these phenomena if done in massive numbers, leads to paralysis (Where this could lead to the Closure of Mutual fund schemes and permanent Loss of Capital for Unitholders).
Paralysis is a situation formed, where this massive redemption eventually affects the operation of mutual funds schemes and forces the mutual fund to sell their investment positions. And this blood bath of selling investments and booking losses leads to negative returns for all the unitholders (Even for those who stay invested). And in extreme cases, it may also lead to the closure of schemes.
The recent example being the Franklin Templeton Case (Where massive redemption of units by unitholder led them into winding up of six debt schemes).
Example of how this Paralysis of ‘Fear of Bear Market’ works?
Let’s assume 10 people with ₹ 10,000 each, got invested in one of the best mutual funds scheme in the country. And this mutual fund company made a great portfolio out of it and invested it as follows:
Initial Portfolio
No. Of Unitholder=10
| Amount Invested | Assets | Type of Asset |
| 5% of Capital (i.e., ₹ 5,000) | Cash and Banks (Meant For daily operations) | Liquid |
| 5% of Capital (i.e., ₹ 5,000) | Cash and Banks (Meant For any future purchasing opportunity) | Liquid |
| Next 30 % (i.e.., ₹ 30,000) | Government Bonds (For Mitigating Volatility and to get assured returns) | Zero Liquidity due to Lock-in-Period |
| Last 60% of Capital (i.e.., ₹ 60,000) | Equity Shares of Great companies. | Highly Liquid |
| Total Amount=₹ 1,00,000 |
Now suppose country goes through a bear market and market falls by say 33% (Almost similar to the fall in the recent covid crash where the market fell by around 37%).
Revised Value of Portfolio (After the Fall)
No. Of Unitholder=10
| Initial Amount Invested | Assets | Revised Value |
| 5% of Capital (i.e., ₹ 5,000) | Cash and Banks (Meant For daily operations) | ₹5,000 |
| 5% of Capital (i.e., ₹ 5,000) | Cash and Banks (Meant For any future purchasing opportunity) | ₹5,000 |
| Next 30 % (i.e.., ₹ 30,000) | Fixed Deposits or Government Bonds (For Mitigating Volatility and to get assured returns) | ₹ 30,000 |
| Last 60% of Capital (i.e.., ₹ 60,000) | Equity Shares of Great companies. (67% of ₹ 60,000) | ₹ 40,000 |
| Total Amount=₹ 1,00,000 | Present Value=₹ 80,000 |
Now seeing the market fall, an individual unitholder begins to panic. And 3 people decide to redeem their investments. Mutual fund company has no problems. They took some cash out of the bank (let us say 50% of what they have) and partially sold their equity investment and redeemed the investor’s investment of ₹ 24,000.
Revised Value of Portfolio (After the Panic Redemption) No. of Investor=7
| Initial Amount Invested | Assets | Revised Value |
| 5% of Capital (i.e., ₹ 5,000) | Cash and Banks (Meant For daily operations) | ₹5,000 |
| 5% of Capital (i.e., ₹ 5,000) | Cash and Banks (Meant For any future purchasing opportunity) | ₹2,500 |
| Next 30 % (i.e.., ₹ 30,000) | Fixed Deposits or Government Bonds (For Mitigating Volatility and to get assured returns) | ₹ 30,000 |
| Last 60% of Capital (i.e.., ₹ 60,000) | Equity Shares of Great companies. | ₹ 18,500 |
| Total Amount=₹ 1,00,000 | Present Value=₹ 56,000 |
Now is when the paralysis kicks in. Unitholders start anticipating a worse future ahead and hence seek prompt redemption of their investment. And this feeling aggravates even more when they see other people doing the same. And this is when a mass number of people reach for redemption and a mutual fund company begins to fall.
In our example let us assume that this massive redemption amounts to 3 more people deciding to redeem their investment. Now since in our example mutual fund company is already feeling the liquidity crunch and their assets being locked in government bonds, they have no option left but to sell off the equity shares and give remaining cash out of the balance meant for operations.
Revised Value of Portfolio (After the Paralysis Kicks in) No. of Investor=4
| Initial Amount Invested | Assets | Revised Value |
| 10% of Capital (i.e., ₹ 10,000) | Cash and Banks (40% of Original Amount meant For daily operations) | ₹2,000 |
| Next 30 % (i.e.., ₹ 30,000) | Fixed Deposits or Government Bonds (For Mitigating Volatility and to get assured returns) | ₹ 30,000 |
| Last 60% of Capital (i.e.., ₹ 60,000) | Equity Shares of Great companies. | ₹ 0 |
| Total Amount=₹ 1,00,000 | ₹ 32,000 |
Aftermath of Paralysis
Now our mutual fund company is operating with only 4 members. They have already tapped their vital cash which was meant for their operations. And any further redemption would only mean that business has to be either halted or else they have to be externally intervened for their survival else they are up-to a painful death.
Somewhat similar to what happened to the Franklin Templeton where the only difference was that their capital was invested in debt securities instead of equity. And those debts securities couldn’t be sold or redeemed under stressed financial conditions. And schemes eventually had to be wound up due to their inability to redeem units of unitholders.
Conclusion
Now you can see that this fear of the bear market is what happened to the above 30 great mutual fund schemes. A bearish market is always a great opportunity to buy great investments at a very cheap price. But while a rational investor munches on this opportunity, mutual fund houses are busy redeeming their units to the unitholder. And more often than not they fail to encash this opportunity. This eventually leads to a lower return over the long period of time (As they couldn’t encash the cheap purchasing opportunity). And in an extreme case, it even kills the mutual fund companies.
Hence, I would like to conclude that mutual funds despite being managed by great managers are at a greater risk to get inflicted by this paralysis. And this one negative point offsets all the positives of mutual funds. And the opposite of this concept also holds equally true (i.e.., An individual investor is always at an immense advantage over the big fund houses if he has the patience to keep himself invested in the market when markets are down and munches on the opportunity that bearish market brings with itself)
Hence next time when you finally decide to enter the market, make sure you make your own decisions and go solo. And if you think you are naïve and cannot make your solo decision, you must opt for more safer options such as Public Provident Funds or maybe government bonds. But in case you still want to get invested in an equity market then you may opt for Close Ended SIPs (they are not completely foolproof but yes they are kind of in a better situation when compared to normal mutual fund schemes) where redemption is not allowed for a certain period (A proactive step taken by MF companies to combat this paralysis).
Happy Investing!!!
Please Note: My Article covers only one of the reasons why mutual funds fail to perform in the long-time horizon. There are more such reasons behind their under-performance, which I’ll try to highlight in my future articles.
Author Bio
Thanks for sharing these kind of valuable information..
Nice!!!