Of Mutual Funds Activism

THE mutual funds industry in Bangladesh is at its infancy. If the mutual fund complex is allowed to develop efficiently and naturally, it improves national rate of savings, helps to mobilize investable funds, acts as an efficient conduit to raise capital and functions as a social safety net. Given the importance of an efficient mutual funds industry, it is important for early participants to remain extra fair and cautious. This is especially true in our country, where misperceptions rule in the mutual funds market. Some outcomes of misperception are overvaluation, excessive trading and perceived irregularities related to pre-IPO placement. A fair amount of activism is necessary by early participants to educate the market. The most pressing objective should be achieving transparency and discipline in the investment process of mutual funds.

While the activism is there, the mission seems to be misdirected. The Financial Express of July 25 reported that representatives of three Asset Management Companies (AMC) out of nine licensed AMCs recently met with the Chairman of the Securities and Exchange Commission (SEC). In that meeting they offered recommendations about the mutual funds industry, which included lifting of margin restrictions, relaxation of limits on pre-IPO placement and reduction of the lock-in period for pre-IPO placements. These recommendations hardly address the real problem of the industry, which is lack of transparency. Liberal use of margins would leverage fund units, which are comprised of stocks that are already overvalued because of over-leverage. Relaxation of placement cap and reduction in lock in period would encourage the business of pre-IPO placement, which seems to have become the main business of some AMCs. This would also encourage excessive trading, which beats the purpose of holding mutual funds. If implemented, these measures would surely benefit asset managers, brokers and beneficiaries of pre-IPO placements. No wonder that some asset managers are resorting to trade-union like behavior in lobbying the regulator. However, if implemented, these measures would continue to perpetuate the problems in the industry. The suggestion that a real fund manager can add value to his portfolio by any means other than stock selection seem appalling to genuine fund managers. Life support such as margin loans or shorter lock-in can prop up the portfolio value for a short-time, but the day of reckoning eventually arrives. Most times it affects small investors who are left with empty bags.

To ensure a steady growth of the industry, we must also ensure transparency in the industry. The first step would be to adopt a universal fund accounting policy. That would ensure that funds own the securities they claim to own, and trade allocation among various accounts is done fairly. Second, funds must announce their holding and their trades at the end of each quarter, along with their net asset value. Third and most important, there has to be an adequate supply of new securities in the market for mutual funds to choose from. Otherwise, funds and retail investors alike would continue chasing the same stocks, ultimately creating unsustainable and bubble-like price levels.