This post will be a long one with lot of data and charts. So, buckle up. And I believe it will be 10 minutes well spent. Even before I tell you what this post is about, look at this chart here. This is the daily rolling returns of two mutual funds in last 15 years. No, they are not direct and regular plans of the same fund. Because direct plans did not exist back in 2005! And Yes, this is from Indian mutual fund industry.

The two funds are HDFC Top 100 which is a Largecap fund and HDFC Equity Fund, a Multicap fund. Many advisors (and investors) want to invest in multiple funds for “diversification”. Whether it is diversification or “di-worse-ification” could be anybody’s guess. Imagine, someone investing in two very different funds with different characteristics and still getting the exact same returns, year after year. And it has happened to lot of folks. This mirroring of returns over such long time period is surreal. Ofcourse these funds have undergone some attribute change over the course of their lives. And yet, they deliver the exact same returns even after such changes.

Few questions pop up immediately:

• AMC has filed them under two separate categories with SEBI – LargeCap and Multicap. So, these are two funds, isn’t it?
• But then how can two different categories give exact same returns year after year? So, they must be one fund.
• Ask any AMC employee, MF distributor or investor and they would swear that these are two funds.
• But but …. look at the chart above and tell me you see two lines? If no, then it is one fund.
• Look at the sales material from the AMC or the NAVs available at AMFI or anywhere else. These are two funds.
• But but but ……….

Phew. Both set of arguments sound logical. So, the big question is – are these two funds or one? Or is it one fund but managed as two funds? Or something else altogether. In this post, we will try to address some of these questions. We will present and evaluate both set of arguments – for and against. Let me also tell you what this post is not about – this is neither a recommendation nor a dissuasion of any fund, fund manager or the AMC discussed or not discussed. This post is an attempt to look at data objectively and make some meaningful inferences from it.

Let us skip investing for a moment and consider this hypothetical situation. Imagine you went to a restaurant (or pizzeria or any eating joint) with your family. The menu typically has couple dozen items! You choose few items, thinking that family members can share little from each dish. And when the order comes through and you taste, you cannot distinguish one dish from another. They all taste the same. I am sure, this has happened with majority of us. It happened to me multiple times, especially on highway dhabas. So, why do different dishes taste the same – because they have the same common “gravy”. Many commercial kitchens make one (or two) common gravy and prep the food in advance. As and when customer orders come, they mix the gravy with vegetables/meats of choice and dishes are served readily.

Coming back to the post, what is common between these two funds?

• One, both are managed by the same fund manager since 15+ years.
• Two, they are both equity funds, hence they will invest in the same universe of stocks. But a few hundred other equity funds also invest in the same universe. No other two funds mirror so much. So maybe we can ignore this reason.
• Third and probably most important, their portfolio construct. It must be similar to a large extent.

As I said we will try to look at both sides of argument. So, let us dive right into it.

Argument 1:
Some might say – the first chart we have seen are point-to-point returns. This is not the correct method of evaluating fund returns. Well, here are annual returns of the two funds:

Had someone invested Rs.100 in each of the fund 15 years ago, the value today would be Rs.604 and Rs.600. Even after 15 long years, the difference in returns is less than 1%. If these were two different funds, then certainly they would have diverged somewhere for any number of reasons – say, different investment strategies or different fund mandates or different investing philosophy? But no. The returns are absolutely mirroring one another. I looked at annual returns it in many different permutations. You may also give it a try. Change the month from Sep to say, Jan. Or Look in batches of 2-year returns or any such thing. No matter what combination one looks at, the correlation between them was always in excess of 95%. That gives a pretty clear picture of how much these two funds are in sync.

Argument 2
Let us look at the common holdings between these two funds. This data is taken from the latest portfolio – as on Oct’20. For easy readability, I have highlighted the lowest (minimum) holding from each fund:

Not only do these funds have lot of common stocks, even the % holding have lot of similarity. For Oct’20, about 70% of portfolio is absolutely common between the two funds. One can argue that this might be a one-off thing. The portfolios could not have been so similar in the past. Or can they? To answer this question, I collated and analyzed the portfolios of both the funds over last 97 months and compared the absolute common holdings:

As you can see, over the last 8 years, the portfolio was absolutely common from low of 65% to as high as 81%. The dotted line is the trendline (average) and it is almost at 74%. Meaning, on average, these funds had about 74% common minimum portfolio. Take a pause for a moment and let that sink in. No wonder they behave so alike and the returns are so similar. You can also read this article to understand how stocks weights effect portfolio returns.

Argument 3
Contrary to popular belief, mutual funds don’t just buy and hold stocks for ‘long term’. They keep buying and selling intermittently for different reasons. Some kosher and some not so kosher. I had written a detailed post on one such fund here. Coming back, let us look at the portfolio sync between these funds. But before that, let us understand ‘sync’. To do that, we will look at one common holding between these funds. The talk of town these days is ITC. So, we will use the same example to understand sync. These are the percentage holding over last 12 months of both the funds:

For easy readability, I have colour coded them as green to red for high to low. We notice there is a great deal of similarity in the pattern and even the changes are in sync. But colours and shades of same colour could be interpreted by different people in different ways. We need a commonly acceptable technique/system to quantify data. For that, we use co-relation. And the co-relation of this dataset is 95.82%. Meaning, they moved in sync to a very high degree.

Now let us look the portfolio correlation of the top holding between these funds for past 12 months. For the sake of brevity, I am just showing the correlation numbers here:

We see that the two funds move in sync (move together) to a large degree. Meaning – the transactions in these portfolios are also in sync to a large extent. In other words, the buy/sell transactions that happens in the portfolio is also very similar between the two funds.

Counter Argument 1
What if past returns and portfolio and even transactions are similar between two funds? One might say, for example, that my portfolio and my friend’s portfolios are also similar. Because we research together and share resources. Very valid point. It means, the base resources are being shared between the two. It is beneficial for both, as the costs are also shared. So, in this case, one might also assume – if the funds are so similar in many respects, the AMC must be managing them at lower costs. Certainly, economies of scale work in almost all sectors, especially in financial services. Let us check this hypothesis with data. For this, I looked at scheme financials. And boy oh boy. AMCs don’t make it easy for anyone to read their scheme financials. They are made available for the sake of compliance but in the most unfriendly format. I had spent hours just cleaning the data. Nonetheless, here we go.

This is the fee charged and approx. AUM for these two funds over past few years. Mar-20 would mean FY 2019-20 and so on:

On average, HDFC Equity fund charges in excess of 1.15% and HDFC Top 100 Fund charges in excess of 1.25% as Management Fee. Even when the AUM increased one-third – from roughly 30K crore to 40K crore, there was no reduction in management fee. We have seen that about 70% of the portfolio is absolutely same for both the funds. Yet, AMC did not relent while charging its fee. So, you see, economies of scale are NOT passed on to investors. The AMC still continues to charges high management fee and treats them as separate funds.

Counter Argument 2:
No more valid points left but for the sake of argument one could say that that these two funds must be small and insignificant and it does not matter whether they are one fund or two. Hmmm… let us look at their historic AUM:

Each of these funds are few thousand crores each. Even as far back in Mar-2012, they both accounted for more than 20% of the AMC’s total AUM. That should give you an idea of how big these two funds were. With regard to how big they are today – many smaller AMC’s total AUM is lesser than just one fund. To give you another perspective, there are 25 AMCs who are smaller than these two funds combined!

This is a screenshot from page 44 the FY 2019-20 annual report of HDFC AMC:

The fund management company itself claims in its Annual Report that these two are their flagship schemes. That should put to rest all doubts whether these are two funds or one.

Conclusion
What could be the profile of investors who put money in these two funds? Let us quickly understand that with a chart (final one, I promise). This data is as on Sep’20:

As with any large AMC, a large majority of investors come via the “Regular” Plan – meaning through the distributors. These two funds are also no different. The distributors could be individuals or companies. Even when your bank’s relationship manager is selling you a fund, it is via the distribution network. Your bank is the distributor. So, when an investment intermediary (advisor/distributor) suggests a product to an investor, they assume that their advisor (or distributor) knows more about it than them. The advisor/distributor must have done their due diligence before recommending it to them. That they must have read the product literature and done the background checks. There could be nothing farther from truth. Just a tiny fraction of advisors do due diligence; majority don’t. And that’s the dirty but sad truth. A vast majority of them rely on AMC “recommendations” or “Head Office Research” and push the same product to their clients. Which beats the whole purpose of advice. Like lot of things, even investments are sold on “TRUST”. An unfortunate reality. A big reason why few thousand crores of investor’s money is stuck when major AMC decided to unwind its debt funds. Or these two funds growing their AUM by 33% inspite of severe under-performance. Usually, there is no one perfect solution to a problem. Especially, for a big problem. Fee based advice is one of the available solutions because investor’s interest and advisor’s interests are aligned.

So, back to the BIG puzzle – is it one fund or two funds? There are no easy answers here. And they may not be black and white. I will present my arguments. And not in any particular order:

• We have seen multiple datapoints and they clearly show the two funds gave exact same returns, year after year. And portfolio mirrors in excess of 70%. And yet the AMC maintains they are two funds. Have they not made a joke of SEBI categorization rules and continuing to do so?
• Is it illegal? Maybe. Maybe not. Depends on who you are asking. Is it ethical? Again, not an easy one to answer. Depends on the person.
• Hypothetical scenario – A company sells you the same shampoo in two different bottles. One is marketed as regular shampoo and other as, say, anti-dandruff shampoo. Would you call that ethical? The answer can vary from person to person. So, you decide whether it is ethical or not.
• With so much overlap in fund selection and fund maintenance, they still continue to charge very high fee. When AMCs say that fund selection and research is a big expense in running any actively managed fund, we have seen that 70% of the fund is absolutely common. Then why should investors still pay such high fee? How is this in best interest of the investor?
• Argument – This AMC has done lot of good work in educating investors and bringing an equity culture to the masses. So, it is alright.
• Counter argument – a) it was a regulatory requirement and b) they were paid to do that. There are no free lunches. Please remember, this the largest and most profitable AMC in the country.
• Argument – Fund manager has taken a call on growth/value/dividend yield (or some other jargon) theme. And hence, the portfolios are similar. So, it is alright.
• Counter argument – yes, a fund manager should have the leeway to take the call and do what is best for the investor. But this “call” has lasted quite long, isn’t it? 15 years and counting!

And we can go on with the debate. There is no end to it. Readers of this blog are intelligent. With all the data, they can now make their own informed decisions. To conclude, I would just say – be aware. Be aware when glossy narratives are being shown to you. Be aware when too much noise (data) is thrown at you. Be aware of whom you are investing and partnering with. Your advisor should make investing easy for you. Not just litter you with jargon and useless quotes. Good advice and a little research goes a long way in avoiding heartburn. And opportunity loss. Until then, live curious.

I am reminded of these lines by Shakespeare from Romoe and Juliet:

What's in a name? That which we call a rose
By any other name would smell as sweet;