I have been a keen follower and student of the equity asset management industry and the way it has evolved and how investors have behaved and should behave in the future. I am laying down some points that I have learned and what I consider are universal truth for everyone and I hope all of you will benefit from this experience which I have learned on account of my own experience in the industry and comprehensive study.
- Equity asset managers who charge just the fixed fee or a fullsome fixed fee including all mutual funds and almost all PMS firms, hedge funds are playing a game called 'Heads I win a lot, you win but less but Tails I still win a lot and you loose a lot'. This is the reason one should stay away from all such managers who are majorly relying on fixed fee for thier revenues. One should read about what Warren Buffett has to say about so called Hedge fund-managers or Private equity guys who are all smart but most of them struggle to beat the benchmark.
Bottomline is - know how the incentives are aligned. Some PMS or MF guy who is charging mostly fixed fee is going to care very less about your long term returns but will care the most about his short term income and fees. So you will loose with such managers in the long term, even if the past track record has been great.
1a. Most PMS managers have shown great perfromance in the past few years but that is not because of any great skill but luck. BSE Small cap index with almost 700 stocks is up 3 times in the past 4 years. So a PMS or a small cap fund like DSP ML saying that they have done 25-45% in the past 3 years means nothing - we will alll know who was swimming naked when there is sustained crash in the market and there is a high chance that a large % of performance will be wiped out in many cases. Basically you will come to know whether your portfolio manager was running a high beta or a alpha portfolio only in bad times and we havent seen it yet.
1b. Most of the PMS strategies are not scalable in India due to lack of liquidity and lack of enough small and mid cap great ideas particularly in these times when valuations have gone up so much. It is a pity that most gullible investors are going to put money now in equity markets when they are already at a all time high and no valuation arbitrage is left on almost most stocks, but particularly in small and mid cap space. So the known PMS funds and small cap mututal funds would struggle to replicate their performance if they have already done so well.
For example, Can fin homes is a favourite for many now when it is trading at a never heard before 7-8 times price to book.
1c. Most importantly, I saw that most of the people are talking about returns here which is not the only important metric in investment management. You should invest with a manager whose style you are comfortable with. And whose funds objectives resonate with yours.
Corollary to this is any asset management company which says that we have multiple strategies each suiting for a different investor is making a fool of investor. No matter how big a team is, equity investing comes down to just one portfolio manager view and he has limited time and bandwidth to know so well so many stocks. And such great managers dont come dime a dozen and certainly they would not stick for long with a broker or a NBFC - most if not all great managers will set up their own firms.
2a. No matter how great a manager is, the size of the investment fund and its performance are inversely correlated. So all the known names that you are talking about are going to struggle a lot in replicating their performance going forward. Some funds I know have produced great returns buying Bajaj Finance at 1-2 times book - how will they perform the same since they are buying the same stock for you at 7-10 times book now.
2b. So what should one do - look for a porfolio manager who is charging most of his fees through performance fee only (Buffett has never charged fixed fee to his investors), one whose own most of the networth is invested alongside you, one who is belongs to value investing style, one who is not already so rich (because if he has already made good money then his incentives may not be aligned with you) and one who has the right pedigree/education/experience in the markets to actually take the right calls (for instance someone coming from a sales or sell side equity research background is already spoiled to make a good manager - someone who has always been on the buy side is much better).
Please understand that all of the above are my own biased views.
If you are wondering if there are any managers who have such qualities, I know atleast one, please ping me and we can have a separate discussion.