Thursday, November 4, 2010

Generating Alpha - Indian Mutual fund Industry

I am surprised that so many mutual funds know so much about the industry they work in and have enough good relationships with the companies' management to give them accurate information about their financing and profit numbers, not to mention where their industry is heading, what their competition is doing and what are the risks they are facing. The research reports I see are really good to read and understand too. But why is it that such informed fund managers not able to produce an alpha (Alpha is a risk-adjusted measure of the so-called active return on an investment. In short, the higher the Alpha, the better the fund managers stock picking skills). The Indian mutual fund industry has missed out on two good rallies one in 2009 and one this year. I see a systemic problem here. They never seem to know when the tide is coming and are constantly caught unawares. The current Indian mutual funds work mostly in a bottom-up approach (I am not refering to the top-down or bottom-up way with respect to sectors and the indian economy, but the bottom I am refering to is the Indian economy and sectors and stocks while the top refers to the global economy). Despite the fact and the characteristic of the Indian stock market that the majority of the investors's money comes from abroad, the mutual fund managers do not give enough importance to the money flow from abroad. They just believe in buying the right stocks and wait till the tide comes and the stocks rise. Though they the mutual funds talk about foreign money and majorly do secondary reasearch on international research reports, I dont think they are talking to foreign portfolio managers and FIIs who are putting and pulling money out of the Indian markets. If the fund managers understand the FIIs concerns and understanding and get the pulse of their investing mood/climate, they can buy stocks just before the tide is going to come and get out before the tide goes back, generating alpha for the investors.

4 comments:

  1. I think what you are referring to is timing the market, and not alpha. It is possible to generate alpha without timing the market and we have some good fund houses in India that have managed to do that. Mutual funds are meant for buy and hold for atleast a moderate amount of time, and not for trading or buying low and selling high. I dont think there are many people (esp money managers) who can boast that they have consistently been able to time the markets.. whether in India or the world.

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  2. To be precise, what you are talking about is increasing/decreasing your exposure to Beta (market timing). So having a greater weighting on cash (zero beta) when you think outflows are likely and higher beta (pehaps even leveraged) when you think there will be inflows. But who are inflows coming from and where are they going? Perhaps you should look at absolute returns and alternative strategies. Sector rotation is something you allude to above, but it is not a very lucrative strategy. In addition there are institutional factors that you must consider (Finance is a business just like any other)...we can discuss this at some point, post your email on my blog: meerkatmonday dot blogspot dot com.

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  3. @DC: I believe timing the market and also taking a view on where the market is headed also is part of managing a fund and generating alpha. My main observation of the Indian mutual fund is that they arent getting a pulse of the FIIs to make some money. At the end of the day, the fund manager makes alpha by only two ways: stocks that perform better than others and the wave of money that rises all the stocks(if the manager misses the wave, just like the other, the chance to generate alpha is also gone).

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  4. @Anonymous: yes, getting in and out of stocks into cash or short term debt is what I am refering to. I agree that there are other strategies, but feel that the Indian MF managers should give more thought to this. Also, yes, the MFs cant hold a very large cash holding even when the expect the market to crash as per SEBI rules.

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