There would be three fund mergers over next two months and all these three schemes have poor performance. Are fund companies opting for fund mergers to hide scheme underperformance?
Over the past one year, as many as seventeen schemes have been discontinued and merged into existing schemes. Three of these schemes have been approved for merger since June 2012. UK Sinha, chairman, Securities Exchange Board of India (SEBI), had expressed concerns over underperformance of equity schemes at a mutual fund summit and said that they encourage merging of schemes. However, fund companies should not choose this as the best way out, he added.
But one can expect some more mergers in the near future as fund houses prefer to merge their underperforming schemes into larger schemes that are performing better. One of the main reasons why fund companies do this is because once a scheme starts underperforming, other investors would shun the scheme and therefore there would be no fresh inflows, in fact existing investors would start exiting. Take the example of the worst performing fund house—JM Financial—which over the past one year has merged 10 schemes into just three schemes. UTI MF too, which has a labyrinth of schemes, has discontinued five schemes and has merged them in to existing schemes.
Many of the schemes that have been merged would have just been fad schemes that were launched during a ‘hot’ period. However, once they got out of fashion and inflows dried up, merger seemed to be the best option. That is why one sees so many sector schemes among the list. We have always warned about sector funds. We have also written that there was nothing ‘contra’ about Contra Funds as these funds fails to live up to their name and objective, ING Contra Fund is one such scheme and has been merged.
If a scheme has a bad track record, it would take a long time before it becomes more appealing. Mergers reduce the management costs for the fund house and erase the bad track record. Schemes with a small corpus can cost more to mange than they generate in fees. The plus for investors is that the expenses ratio could get reduced in cases when the scheme which it is being merged with has a much larger corpus. However, what is more important is the performance of the new scheme.
If one of your schemes has got or is getting merged, then you may have been invested in the wrong scheme from the start. But if the performance has been reasonable, then probably the merging schemes have similar strategies. Therefore, investors must evaluate the new scheme objective whether it is the same and if it fits into your portfolio.
Let’s look at the two mergers that will be executed this August. SBI One India Fund will be merged into SBI Magnum Equity Fund and Principal Services Industries Fund will be merged into Principal Growth Fund. Both these schemes that are being phased out have pathetic performance. In the last thirty three-year rolling periods from 1 January 2007 to 30 June 2012, SBI One India Fund has underperformed the benchmark on 27 occasions and Principal Services Industries Fund has underperformed the benchmark on all but two occasions. Both these schemes have underperformed their respective benchmark by an average of two to three percentage points.
The investors of the SBI scheme would be better off in the new scheme—SBI Magnum Equity Fund—as it has underperformed the benchmark just twice and the expense ratio would come down from 2.27% to 2.24%. However, the same cannot be said of the Principal scheme. Other than the reduction in expense ratio, the performance of the new scheme is just as bad, underperforming the benchmark 29 times out of 30. There are better performing schemes of other fund houses which one can choose as well.
It is important for investors to keep a track of their schemes and keep an eye open for deteriorating performance. If your scheme begins to underperform its benchmark regularly it is time you switch and opt for better performing schemes.
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