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Mutual funds on thin ICE

It is not quite clear if the ICE (information technology, communications and entertainment) party is truly over, but going by the newspapers (specifically the print media), it would seem that the world is writing the epitaph of weird dot com valuations.

Everyone watched with disbelief as the savviest of investors/fund managers and financial experts trotted out bizarre justifications for projects that do not even hold out the hope of earning real revenues. Even more unnerving was that these justifications seemed to have global acceptance. One fund manager correctly described it as the 'globalisation of insanity'.

The hangover of the ICE-driven party is apparent in India too. Monday morning saw the prices of what were once known as the K-10 scrips (or those scrips driven, pied-piper fashion by a single operators and all those fund managers who were persuaded to stuff their portfolios with the stocks) dip dramatically again. Most are already down to half. Trading indicators suggest panic-stricken sales being pressed by small-time punters and big-time fund managers. Net asset values (NAVs) of mutual funds have been crashing and the regulators need to ask tough questions.

While it is still early to say if the party is truly over, a couple of areas merit attention. The first is clearly mutual funds. These are expert traders, backed by serious research and access to companies who know how to distribute their portfolio in order to maximise returns or minimise risk.

Manubhai Shah, managing trustee of India's largest consumer group, the Consumer Education and Research Centre of Ahmedabad, has for several years argued that mutual fund managers and trustees have to be made more accountable. He has argued that investors are willing to accept low returns or no-returns in a bad market, but not erosion of their principal. He contends that when returns fall below what an investor would earn on a savings bank account, the onus should shift to the fund manager and mutual fund trustees to establish that there were no mala fide intentions and that their decisions were based on research and logic. This debate has remained inconclusive ever since the market crashed after the securities scam of 1992 and revealed a gaping hole in the holdings of Canstar.

Then Unit Trust of India's flagship US-64 scheme declared a whopping erosion in its NAV last year, threatening a financial crisis. The government decided that UTI was too big to fail and a Rs 48 billion bailout followed. It was further sweetened with such enormous tax breaks that the entire mutual fund industry went through a huge boom.

As more schemes were launched and private mutual funds began to collect billions of rupees, their returns also soared in line with a huge bull run. At around the same time, the rules began to be diluted and the regulators to become careless.

Several funds have brazenly breached the five per cent limit for investment in single scrips. Even so called balanced funds are now found chock-full of IT or ICE stocks whose values have been dropping eight per cent every day (the lower circuit barrier on Indian stock exchanges). The postal ballot mechanism has been done away with and several schemes have increased fees to the asset managers, added loads and extended turnaround time for redemption.

Today NAVs have crashed enough to warrant some explanations. While it is true that several IT funds did warn investors, the balanced funds will have to explain themselves, so would those which breached the rules. An investor, Chandrashekar Joshi writes to me that he holds fund managers responsible for fueling greed by cornering shares at the time of primary offerings and helping generate false hype about the stocks.

Sadder still is this letter from a farming family in the north. Carried away by the hype and on the advice of a banker friend, the family sold its land and invested in the market. To play safe they opted for mutual funds - growth, IT and tech stocks - paying the highest rates at the prevailing NAVs. A family member says, "Within 15 days it (net asset values) dipped so badly… I have never invested in shares… only I thought MFs are safe… Now the NAV is so low and the exit loads are so high… the loss is around Rs 700,000-900,000… I don't know whom to contact … what to do… or see our hard earned money getting lost." Who can help this investor once his money is lost?

That is indeed the crux of investors' problems today. There are plenty of people who work at helping investors' lose money. Several investors have written to me to complain about the role of the media. Financial papers which recommended scrips such as Global Tele-systems, Infosys and Satyam at prices of Rs 3000, 13,000 and 1500 respectively are silent when values halved. Most dangerous are television programmes which give instant portfolio advice. I've received two letters from investors about a particularly glaring example where just over a fortnight ago, an investor who had bought Infosys at Rs 200 was advised to hold tight to the stock. "Never sell Infosys," he was told.

Something that is totally contrary to the cardinal rule of 'never fall in love with your stocks'. We hope that the investor ignored the TV advice and sold his shares, otherwise he would have seen his wealth diminish by a half. On the other hand, if he had indeed sold then, he could have bought the shares back at these levels and converted ephemeral paper profits into real money.

All those advisers who predicted a ten-year bull run, the Sensex at 6600 or those who were even more specific about particular stocks have since vanished from the television screens. In the US, investment advisors are regulated and have to be registered with the Securities Exchange Commission. In India too, a muted demand for some sort of regulation of financial journalists and investment advisors/portfolio managers who double up as columnists surfaces every time there is a big fall in the market.

Now that dot coms are being reassessed and ICE scrips are falling, it may be time to take a serious look at this demand. After all the press does play a big role in influencing people and it is exploited by speculators as well as the regulators. Investors should also remember that regulating intermediaries and investment advisors is no substitute for their own prudence.

Sucheta Dalal

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