Small Funds. Big Winners from. Interview 31 Harshad Patwardhan of JP Morgan AMC on his outlook for markets. Category Watch 43 Multi-cap funds

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1 January 2015 `150 Interview 31 Harshad Patwardhan of JP Morgan AMC on his outlook for markets Category Watch 43 Multi-cap funds Getting Personal 16 V Shankar, founder of CAMS, on personal and professional life Scorecard 61 A complete guide to funds Registered with the Registrar of Newspapers for India, Registration Number DELENG/2003/11417 Big Winners from Small Funds

2 BIG WINNERS FROM SMALL FUNDS Even though investors often ignore them, smaller fund houses have plenty of good funds

3 Aarati Krishnan The Indian mutual fund industry is very spiritual. Everyone is focused on AUM, an industry veteran joked a few years ago. By AUM he was referring not to the Hindu prayer but to assets under management, the magic number by which fund houses are judged, fund managers are paid and distributors decide whether or not to sell a scheme to investors. This obsession with AUM has led to a widening divergence in the industry. While the four biggest fund houses today manage in excess of `1 lakh crore each in AUM, the four smallest ones manage less than `500 crore each. Value Research has always believed that size has little to do with fund performance. If a scheme has managed benchmark and category-beating performance over the long term and it belongs to your portfolio, never mind it s AUM. But given the industry and distributor focus on AUM, it is quite likely that small schemes with good performance would slip under the investors radar. This is why we decided to run a detailed analysis of smaller fund houses to find out which ones have delivered the best consistent show across their debt, equity and hybrid schemes. The exercise helped spotlight good schemes from these fund houses, which you should consider for your portfolio. For the analysis, we first filtered the 45 Indian fund houses by AUM and considered only those with less than `20,000 crore AUM (based on average assets for the July September 2014 quarter, from AMFI). As performance over an entire market cycle is critical, we excluded small AMCs and individual schemes within the AMCs which don t have a 5-year track record. The analysis demolished some of the common misconceptions about investing with smaller houses. Here are our findings. Size has little to do with fund performance. Don t mind the AUM if a scheme has managed benchmarkand category-beating performance SMALL DOESN T MEAN POOR PERFORMANCE If it s small, it can t be good. That s the usual perception among distributors and investors in the mutual fund industry. But an analysis of returns from smaller AMCs proves otherwise. We evaluated the returns of all the schemes from smaller AMCs to see what proportion of their schemes (across equity, debt, hybrid and international categories) beats their respective benchmarks over a 3- and 5-year period. Many small AMCs fared surprisingly well. A full per cent of the schemes managed by Canara Robeco, Principal, JP Morgan, BNP Paribas, Taurus, Quantum and Escorts beat their respective benchmarks over the choppy debt and equity markets of the last five years. We double-checked the rating distribution of schemes from smaller AMCs in the Value Research rankings too. Here again, some small AMCs fared well. Two out of three schemes of Quantum Mutual Fund, for instance, have a 4-star rating with Value Research. Seven out of the ten schemes managed by MiraeAsset enjoy a 4- or 5-star rating. Five out of the seven schemes managed by Escorts Mutual Fund enjoy the top 5-star rating in the debt category. Agreed, some small AMCs have managed a consistent show across their schemes. But how do they stack up against their bigger competitors? We found that quite a few schemes from smaller AMCs figure among the top five or ten funds across equity and debt fund categories if we take stock of 5-year performance. For instance, Mirae Asset India Opportunities is the top ranker on 5-year returns in the large and mid-cap equity category, while Quantum Long Term Equity also figures among the top five in the same class of funds. Religare Invesco s Midcap and Smallcap Fund and its Midcap Fund both figure among the top ten 36 Mutual Fund Insight January 2015

4 funds in the mid- and small-cap category over 5 years. CanRobeco Emerging Equities and BNP Paribas Midcap too are among the top ten funds in the mid- and small-cap category. Even in debt funds, where size is celebrated, Escorts Mutual Fund has its schemes among the top three across the shortterm income, income as well as liquid categories. These statistics show that smaller AMCs don t suffer from any handicap on performance and are capable of being as wellmanaged as larger houses. In fact, a smaller AUM could turn out to be an advantage for schemes operating in some equity categories such as mid/small/micro-caps and thematic funds because large funds in these classes can face liquidity and impact costs. WHY SMALL? But if smaller AMCs do have top performing schemes, why haven t they attracted assets? In the open-end structure, shouldn t good returns automatically lead to inflows from investors? If that s your worry, flows don t always follow performance. Despite delivering good returns, some AMCs can lose out in the AUM race either because they don t actively woo distributors or because most large distributors don t consider schemes below a certain size. Despite being around since 2006 and delivering good returns across schemes, Quantum AMC, which uses an all-direct model, manages under `600 crore AUM across all its schemes. Says Ms Viji Krishnan, CEO of BNP Paribas Mutual Fund, which has several top-rated equity funds in its kitty, Though our equity funds have been good performers for the last three years, it has taken a great deal of effort to grow our equity AUM from `300 to `1,000 crore. The perennial issue we ve had is that distributors across categories simply won t look at any scheme or AMC that is less than `500 crore in assets. Distributors may have reasons for not selling them. But retail investors should not lose out on the chance to own a good scheme that tops its category just because it comes from a small AMC. Here are six small AMCs and the top-rated schemes from them. WHO SAID SMALL AMCs AREN T SERIOUS? Many misconceptions abound with small AMCs, from the fear of consolidation to non-serious business practices Returns apart, one fear that seems to often haunt distributors and investors about small AMCs is that they would become victims of consolidation or an ownership change. To be sure, a number of sponsors of Indian mutual funds have thrown in the towel in the last ten years, either due to a bout of global restructuring by their parent or because they lost patience with the slow growth in the India business. But investors should take note of one thing. Many of the AMCs which quit India or sold their MF business were actually industry leaders. In the first wave of consolidation in MFs in the nineties, leading names like Kothari Pioneer and ITC Threadneedle exited the space. After the tech stock crash, again, two of the most successful houses, Alliance Mutual Fund Insight January

5 Six small AMCs to watch out for BNP Paribas Mutual Fund `3,855 crore 5 of 11 Canara Robeco Mutual Fund `6,890 crore 8 of 14 Track record: 100% of equity funds and 71% of debt funds beat benchmark USP: Strong risk controls, business-managementvaluation model for stock selection Net worth: Already SEBI compliant (`170 crore as of March, 2014) Funds to buy: BNP Paribas Long Term Equity, BNP Paribas Dividend Yield, BNP Paribas Midcap Strong outperformer across equity funds, good show in debt funds Track record: 100% of equity/balanced schemes and 73% of debt schemes beat benchmarks over 5 years USP: Macro analysis leading to good equity as well as debt calls Net worth: Already SEBI compliant (`98.2 crore as of March, 2014) Funds to buy: Canara Robeco Emerging Equities, Canara Robeco Balance Equity fund outperformer, debt funds okay, liquid/gilt funds need improvement Mirae Asset Global Investments `1,483 crore 4 of 6 Track record: 90% of equity funds beat benchmark USP: Stocks selected through quality growth at a reasonable price, focused on cash flows Net worth: Already SEBI compliant (`123.5 crore as of December, 2013) Funds to buy: Mirae Asset India Opportunities, Mirae Asset Emerging Bluechip Very consistent show in domestic equity funds, but debt record is patchy Principal PNB Mutual Fund `4,708 crore 2 of 16 Track record: 75% of equity/balanced schemes and 90% of debt schemes beat benchmarks USP: Quality focused, strong in large-cap equity Net worth: Will be brought in by sponsor (`19.6 crore as of March, 2014) Funds to buy: Principal Large Cap, Principal Tax Savings Consistency is its forte. Not many top ranking schemes, but majority ahead of benchmarks Quantum Mutual Fund `563 crore Track record: 100% of equity schemes and liquid fund beat benchmark, gold fund lags USP: Valuation-based triggers to profit booking, cash calls, ultra-low expenses Net worth: To be brought in by sponsor (`28 crore as of March, 2014) Funds to buy: Quantum Long Term Equity, Quantum Tax Savings 2 of 3 Good risk controls and low costs make it a top choice across categories Religare Invesco Mutual Fund `19,215 crore Track record: 93% of equity schemes and 55% debt schemes beat benchmark USP: Conservative, growth-style investing based on deep fundamental analysis Net worth: Already SEBI compliant (`57 crore as of May 2014) Funds to buy: Religare Mid and Smallcap, Religare Tax Plan 5 of 23 Strong outperformer in thematic and mid/smallcap equity; debt funds need improvement 38 Mutual Fund Insight January 2015

6 and Zurich, sold out. In the latest round of consolidation post 2008, global giants like Standard Chartered, Fidelity, Morgan Stanley and AIG sold out. Therefore, ownership change is as much of a risk with a larger AMC as it is with a smaller one. As such changes in any case cannot be predicted, and you do get an exit option when the fund ownership changes, it would be best not to worry too much about this factor when selecting your funds and to base your decision only on scheme performance. NET WORTH ISSUES If ownership change is one issue, the perception that small AMCs are non-serious about the business is another. In fact, the regulator SEBI seems to believe in this too. In February this year, it had asked all AMCs to ensure that they had a minimum net worth of `50 crore on their balance sheet. Fund houses were given three years time to comply with these regulations. At the time this regulation was notified, about 19 AMCs failed the `50 crore net worth test, many of them small fund houses. After this regulation, many of the smaller AMCs such as Principal, Religare Invesco, BNP Paribas, Motilal Oswal and Parag Parikh Financial Advisory Services have seen their sponsors chip in or committing to chip in with the higher capital to comply with these norms. Others are expecting their profits to shore up their net worth within three years. We don t have a godfather nor do we have a magic wand to help us raise `50 crore in one shot. However, looking at the growth of our funds and current AMC profitability, the funding gap should narrow down quite significantly in three years. We expect our future profits to help us cross the `50 crore net worth requirement. Besides, our sponsor, Quantum Advisors, has the requisite capital In fact, the SEBI also seems to believe that small AMCs are not very serious about their business practices, which lowers their credibility to fund the AMC, says Jimmy Patel, CEO of Quantum AMC. But irrespective of whether they meet minimum capital norms, some small AMCs have, in fact, proved to be far more investorfriendly in their approaches to business than some large fund houses. The tiny Quantum Mutual fund (AUM `563 crore), for instance, has adopted a directto-investor model and completely avoided marketing its products through distributors from Day 1. This has kept the fund s AUM minuscule but it has delivered excellent results for investors. Not only does the direct model prevent practices such as mis-selling, it keeps the fund s expense ratios ultra-low, allowing a higher part of the fund s portfolio returns to flow straight to the investor. Quantum Long Term Equity Fund, despite being a 4-star rated fund, charges an annual expense ratio of just 1.25 per cent, while most other peers in the category charge over 2.50 per cent. Many small AMCs, including Quantum, Escorts, Mirae, MotilalOswal and the recently launched Parag Parikh Mutual Fund have opted for niche business models that focus on one category of funds. They have refrained from rolling out an unending stream of NFOs and have focused instead on delivering good performance on the handful of schemes that they do manage. A compact portfolio of funds not only helps the CIO and fund managers focus enough attention on each scheme it also raises the stakes for the AMC. After all, a fund house with schemes on the menu can afford to have its schemes strewn all over the performance rankings. At any point in time, it will always have a few schemes performing well enough to be showcased to investors and distributors. But for a smaller AMC with just a few schemes, the stakes are much higher. They have only two choices: perform or perish. 40 Mutual Fund Insight January 2015