We consider a lot of factors before investing in a mutual fund scheme. We look at returns, risk, nature of schemes, AMC track record etc. While looking at all these things to consider before investing in mutual funds, what we sub-consciously take a view on the fund house. How research mutual funds is also about the fund house to which the fund belongs. After all, the business of mutual funds is a business of size. Without scale it is impossible to survive in this business for too long. Even globally, the fund management business is dominated by names like Vanguard, Fidelity, Blackstone, Blackrock, Templeton etc. These are the funds that typically get most of the flows. Even in India, the flows typically gravitate towards a handful of AMCs like HDFC AMC, ICICI Pru AMC, SBI AMC, Kotak AMC, Templeton AMC etc. Why is that the case?
1. Performance is a proxy for the fund house
It has been generally seen that the large fund houses manage to outperform markets over longer periods of time. There are various reasons. Since their AUM is large, they are able to beat down costs to very low levels. Secondly, due to their strong capitalization they are able to handle any sudden redemption pressure quite effectively. Unlike, smaller funds they are not required to maintain higher levels of liquid cash and that enhances returns.
2. Comfort level comes with pedigree
Typically, comfort level comes with pedigree and pedigree comes with familiarity. That is where investor money tends to gravitate. If you look at the top 5 funds in India by AUM, they are all companies that touch your lives on a daily basis. ICICI, HDFC, SBI, Birla and Reliance are all brands that touch your lives on a daily basis. It is this familiarity that helps investors to identify with them, which explains why there is a stronger preference for such AMC houses.
3. Higher levels of corporate governance
A mutual fund manages public money and therefore has to maintain highest standards of corporate governance. The fund needs to ensure that the fund manager’s interests and actions are aligned to the interests of the investors. If the fund manager is incentivized to generate more return at any cost then they will take on more risk. This is surely not in the interest of unit holders. Larger AMCs with better pedigrees tend to have stronger due diligence processes and internal controls. Also, their board of trustees is more proactive in highlighting such deviations. That protects investor interests better.
4. Ability to attract and retain the best talent
Fund management is essentially a soft skills business and a lot depends on the kind of team you are able to build. Large fund houses with bigger AUMs are able to hire and retain the best talent as they have greater staying power in the business. Fund management is a business of hard skills, soft skills and long term commitment to the business. That is possible only when you are able to build a quality team and incentivize them long enough to sustain in the business. Larger fund houses have a better ability to do that.
5. Backing of a big fund house means commitments get honoured
We have seen fund houses in the past folding up operations thus leaving investors in the lurch. That happened in the case of CRB Mutual Fund in the late 90s and later in the case of Dundee Mutual Fund in early 2000s. Even in the case of Alliance MF, which was taken over by the Birla Group, investors were put through hardship. On the contrary, JP Morgan Fund despite being a small fund honoured its commitments during the debt fund crisis due to the backing of its strong parent. That is why the capital strength of a fund house matters as it implies that commitments get honoured even in a crisis.
6. Bigger houses can invest in distribution and marketing
The rule is that investors do not go to mutual funds. On the contrary it is the mutual funds that have to go to investors. That means large distribution and marketing networks. A huge army of feet-on-street salesmen, brokers, sub-brokers and franchisees need to be selling the products. That calls for a huge investment and only the large and well capitalized houses can afford to invest. When a fund comes to you, it is more often a large house with the distribution reach and pedigree.
7. Bancassurance and conglomerates have a big advantage for cross sales
If you see the top 5 fund houses then 3 are bank affiliates (ICICI, HDFC and SBI) while 2 are conglomerates (Reliance and Birla). All five have vast customer outreach and are able to economise on their marketing and distribution costs through the benefits of cross selling. That is the advantage a lot of smaller fund houses does not have which makes their cost structures almost inefficient.
At the end of the day the name of the AMC matters a lot. Performance alone is enough as investors need to be convinced that the money is being managed by a reputed group with pedigree and that they have the capacity to honour their commitment. That is the reason the size and the quality of the AMC matters a lot in your fund decision.