In this post, we will look at Equity Multicap Funds. We will also see, at a macro level, if there is relationship between performance and AMC size. And finally, we will touch on some challenges facing the industry and what can investors do to overcome those. Let me also tell you what this post is not about: This is not a category or fund review. This is not recommendation to buy or to avoid any fund. Rather this is an attempt to look at big picture and draw some insights from it.

Multicap is the second largest category of equity funds and has about 20% of the equity AUM. I particularly like this category as it is not bound by bizarre market capitalization rules or impositions of sectors industries or themes. In addition, the fund can take cash calls, if needed. Through arbitrage route or through TREPS. In short, Multicap funds can invest almost anywhere. To give a parallel – pretty much like the Queen in the game of chess, which can move almost anywhere on the chessboard.

To give a quick introduction, SEBI’s categorization criteria states that Multicap Funds can invest across market capitalization with investment in equity and equity related instruments of at least 65%. Pretty straightforward. This category now has 34 funds. The exceptions are BOI AXA, IIFL, IndiaBulls, ITI, Quantum and Yes.

The AUM distribution is very typical:

Top 9 funds (or 25% of funds) have 77% of the total AUM. Top 17 (or 50% of funds) have almost 96% of AUM. One possible explanation for the skewness is the fact that Mutual Funds are still a push product. Meaning, they are sold by intermediaries rather than being bought by investors. Let me share a dataset to support this claim:

Blue column is the AUM through distribution channel – what is also called Regular plan. The distribution channel or intermediaries “sell” these funds and they get commission as a % of AUM. The green column is the Direct plan – “bought” by investors directly from the AMC bypassing the distribution network. On average, regular plans account for about 75% of the total AUM. In other words, Regular is three times that of Direct.

From this data, we can draw two conclusions:
a) These 9 AMCs have lion’s share of the AUM and
b) Very large part of it was sold in Regular Plan through distribution network

This can also be interpreted that investors have put lot of faith (and money) with these advisors and funds. Let us see how these funds have fared on the performance front. Rather than looking at plain vanilla % returns, we will look at Alpha. In investing world, Alpha is the excess return over and above the benchmark. If a fund generates better than benchmark returns, it is positive alpha and vice versa.

1 year is too short a timeframe to evaluate an equity fund. For the 3-year period, other than UTI, none of the others have done any value addition. The 5-year period is a mixed bag. 5 funds with positive alpha and 4 funds with negative alpha. A point to note here: obviously AUM keeps changing month on month. The reason I have put it here is to draw your attention towards AUM share and Alpha.

But one might argue here saying that I have used selective data points, after market correction. OK, point taken. Let us see their alpha at the peak of market in Jan’2020.

We can ignore the 1 and 2-year periods but do have a look at their alpha. In the 3-year period, just 1 fund was able to generate positive Alpha. In 5-year period – UTI and Kotak were positive and were positive in all timeframes. Birla, Motilal and SBI were one-time hero and then constant under-performance in all other time periods. And funds like Franklin, HDFC, ICICI and Nippon are hugely underperforming in all time periods. They were unable to beat the benchmark even at the peak of market. This speaks volumes about ability of fund managers to generate returns for you.

Multicap funds of Franklin, HDFC, ICICI and Nippon were unable to beat the benchmark even at the peak of market

Let us break this Alpha in year-wise chunks and try to make more sense of it:

The bulk of 5-year alpha seems to have been generated during the bull phase of 2014-15. For full 4 years, from 2016 to 2019, they have massively under-performed. Some funds generated patchy alpha of just around 5%. No consistency. The negative alpha far outnumbers positive alpha. The whole point of investing in an active fund is to generate returns better than the benchmark. Hence investors pay much higher fund management fee vis-à-vis an index fund or an ETF. Lot of time and energy is spent looking for “best” fund. If this is the alpha generated by the top fund managers then a pertinent question that need to be asked is – would investors not be better off by simply investing in Nifty 500 index fund?

If this is the performance from top fund managers then why not simply invest in Nifty 500 index fund?

Now, let us also look at the performance of the next set of 8 funds:

These 8 funds have AUM share of less than 3% each. Yet 3 of them have generated positive alpha in all 3 timeframes. And 3 funds don’t have a 5-year track record – Axis, Mirae and Tata.

Like we did above, let us look at their Alpha at peak of market in Jan’20:

Notice the pattern here. Outperformers like DSP and PPFAS have been able to beat benchmark across all timeframes consistently. Then, funds like Axis and TATA don’t have a 5-year record. Mirae didn’t even have a 1-year track on Jan’20.

This is the summary of the data we had seen above:

Let me warn you, this is not a comparable dataset. 3 of 8 funds in the second set don’t have a 5-year track record. And more importantly, one cannot invest in 8-9 funds and then look at median returns 5 years later. The only reason I am showing this data here is to highlight the stark difference in performance between the two sets. The first set predominantly consists of large AMCs and second set is made up of relatively smaller AMCs or new entrants. You will notice that the second set has undeniably fared well in all parameters. What could explain this huge difference in performance between “big” and “small” funds:

• Distribution network: Large and older AMCs have bigger distribution network. In addition to the large IFA (Individual Financial Advisor) workforce, they have tie-ups with national distributors, banks, wealth management firms, stock brokers and NBFCs. Some of them also have the advantage of their group companies in banking/NBFC space. Naturally, their product gets more “push”.

• Incentive structure: This industry’s incentives structure skewed. Equity funds get much more in commissions than debt funds. Hybrid funds, which are a mix of equity and hybrid, can get as much as equity and sometimes even more. Naturally, intermediaries tend to gravitate towards products offering higher commissions, notwithstanding client needs. The other side of coin – AMCs give “extra trail” commission for starting X number of SIPs in certain months. A banker gets extra “credit” for selling say, a balanced fund. An AMC promises foreign trip on achieving a specified “target” of sales. Where are the interests of the investor in all this? Definitely gone for a toss. And more importantly the intermediary has no skin in the game. They get their promised piece of silver irrespective of scheme performance. Larger AMCs are able to promise and deliver these extra incentives because they have a larger promotion and sales budget.

• Availability: The moment banker realizes you have surplus money in your account, a “friendly” advisor materializes. When you search for Multicap Mutual Funds in Google, the top results are from “fund rating” websites. During a social gathering, some friend introduces to an “advisor” who will assist you with your investments. Do you see the common thread here? Financial advice, easily available and that too for free! If you take a service, expect to pay for it. If you are not paying for it knowingly and transparently, then high probability that you will be sold a lemon. No advisor will spend hours and shortlist good funds for you for free. Why would some website spend few crores in data/employees/hosting and give you fund ratings for free? Bigger AMCs have deeper pockets. They get more traction because they are able to buy “advertising” from these websites. Just because financial advice is freely available, does not mean it is the right advice. The future costs of free advice could be far worse.

• AUM race: Unfortunately, few AMCs in the industry follow one and only metric – who has the largest AUM. Some of them have morphed into sales organizations from being asset managers. Look at their organization structure – there is national sales head, regional sales head, zonal sales head, branch sales head and what not. Focus is on asset gathering rather than managing current assets well or managing risks better. Unlike in manufacturing, there is no unit cost in financial services. The fixed costs for an AMC with 10,000 Cr are not very different than an AMC with 50,000 Cr in AUM. Every additional rupee in AUM beyond the break-even, directly adds to the bottomline of the AMC. Top brass and fund manager’s bonuses are linked to sales and AUM. Bigger AUM automatically means bigger bonuses. Performance takes a backseat as focus shifts on AUM gathering.

These arguments are not standalone. They are intertwined with each other and have a feedback loop. More importantly, this is not limited to just Multicap Funds. Take a look at any equity fund category. None of the large AMCs feature in top quartile performance. Is it not odd that large AMCs who pay top money to attract best talent, have the best resources at disposal and yet, deliver mediocre performance? Year upon year. Having said that, we cannot paint everything by the same brush. Fund management is the sum total of lot of moving parts. Some of them have outstanding teams and great processes. But end of day, an investor wants the money to grow. The results of great team and great processes should also reflect in the higher NAVs. Only then it is a win-win deal for all stakeholders.

None of the large AMCs feature in top quartile performance !

What can investors do – ask yourself – is the recommended product really suitable for me? Can I make do with 2 funds instead of 6? Do I really need diversification within a category? Understand the risks better than promised returns. Look beyond the fancy presentations or AUM numbers. And most importantly – ask questions. Just doing these basic sanity checks can help you achieve better than average returns.