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Opinion

All that glitters is not gold, Quantum

Quantum Mutual fund says they are a “different” kind of fund. They have no distributors (you must buy from them or from Personalfn or Equitymaster, their own sites) and say they are a low cost fund. Meaning, you pay no entry load, and no distributor commissions. Plus, they don’t do big advertisements or spend on canvassing money.

On their home page I have noticed some articles. Recently they talked about how your money is looted by “high cost” funds (the ones you regularly hear of such as HDFC Equity or Reliance Vision and so on) – essentially, by charging you for distributor commissions, TV advertisements, billboard costs, etc. through fund management charges. This reduces the total amount of money you have, and therefore your returns.

I agree with them when it comes to entry load. Read my post on How Entry and Exit loads can affect you – where I compare your real returns through ETFs, zero load funds and full-load funds.

But they are wrong when it comes to the whole picture. To give you an example: HDFC Equity fund has more than 4500 cr. under management. The net expense ratio of the fund is 1.83%.

Quantum Long Term Equity fund manages 37 cr. and charges you 2.5%.

For you the story goes like this. If you had 1 lakh in HDFC Equity fund, (ignore the entry load, we’ll come to that later) – the expenses charged to you would have been Rs. 1830. And if you had the same 1 lakh in Quantum long term equity fund, your cost would have been Rs. 2500.

Meaning, Quantum, with all its “low-cost” statements, actually costs you more (on an ongoing basis) than a “high cost” mutual fund like HDFC Equity.

Note: If you had INVESTED the money in the funds one year ago, your story would be different, because entry load for HDFC Equity – 2.25% – would have taken another 2,250 from you making it a worse return. I agree with Quantum on its lower entry load but they compensate by putting in a higher exit load so the next effect is the same if you were to need money today.

Now, how do the 1 year returns compare? Quantum LTEF made 25%. HDFC Equity made 37%. Your one lakh would be worth 1.25 lakhs with Quantum and 1.37 with HDFC Equity. Not only has HDFC charged you lesser as costs, they have also delivered superior returns (so when you consider even that 2.25% entry load, they have done better than Quantum).

Low cost does not necessarily mean better. Sony TVs and Toshiba Laptops are not cheap. And if you still want to go zero load you can choose index funds (like UTI Master Index, UTI Nifty Index etc.) which charge you 0% entry load. (Both those funds returned over 30% last year, and their expense ratios are 0.75%)

Quantum has said that their one year performance is weak because they did not fall that much last year (during the downturn). So when they didn’t fall that much the bounce does not look good. This is a mathematical flaw. If the market went up 50% in one year, you should have made 50% in the last one year (or more, otherwise why should we give you the money).

Just because they lost lesser in the downturn doesn’t mean they should be excused for underperforming when the markets go up. The return difference is so big (nearly 12%!) that it merits concern. To save one or two percent in costs, we are giving up 12% in returns?

Quantum stayed in cash last year during the dip and when valuations were low (at 9000 or so). But they remained in cash even after that. Perhaps that was a mistake. After all, I wouldn’t pay someone else to NOT invest my money, would I? Secondly their calls just haven’t been as good as the others. That’s also ok, every fund manager has his day. And finally, they charge you the maximum amount they can – 2.5% – as management fees.

I think it’s easier if Quantum admitted it as their mistake instead of weaving excuses for their underperformance. And although they try to come across as the low cost fund, their fund can actually costs you more, as we’ve seen in the recent past.

I’ve met Ajit Dayal, the founder of Quantum, during an investor meet in Bangalore. I think he’s a smart chap. But perhaps these guys need to sit down and work out how they must deliver really low cost and high quality returns – like the Vanguard funds in the US. To be honest I think funds from Benchmark (NiftyBeES, Junior BeES etc.) are lower cost than any others I have ever seen, even if you considered brokerage costs.

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  • Jackson David says:

    >I fully agree with your views on Quantum. IMHO the same holds true for the cost differential between ETFs and diversified open end funds.

    It is true that costs are not insignificant. But is the Indian market mature enough for passive funds to match returns of good actively managed funds over long term?

    And with much higher absolute returns than developed markets, even a small percentage of out-performance can easily cover the expenses. Will you advise investors to choose index funds as long term investment vehicles? They indeed are a better option for short term or arbitrage moves.

  • Deepak Shenoy says:

    >Jackson: I would agree with you where there is overperformance. Some funds like JM Basic have outperformed everything in existence. Sector funds like banking and infrastructure have also beaten the indices.

    I would put more money on passive funds going forward, as the markets mature we will find more activity in the indices on a diversified strategy. If you get stock specific it would be my choice to buy stocks myself rather than buy a fund.

    I should write a post on diversified equity performance and see how things have gone in the last few months.

    You’re right, cheaper doesn’t necessarily mean better. So a small difference in costs/expenses may not be worth giving up a large difference in returns.

  • Nagesh Pai says:

    >Dear Deepak,

    Thank you for writing about Quantum mutual fund in your blog.

    To start with, except for a common approach and philosophy to focus on the long term, Quantum Information Services (which owns the web sites http://www.personalfn.com and http://www.equitymaster.com) and Quantum Asset Management Company are 2 different companies.

    Quantum AMC was created with the following in mind:
    1) Offer investors a low-cost approach to investing with a view that, over the long-run, lower costs will increase returns while higher costs will hurt investor returns;
    2) Offer investors limited and simple products that cater to their long term investment needs: other mutual fund houses have, for example, 10 or 20 equity schemes some of which may perform well and others may not. Multiple schemes are great for a distribution-led, asset-gathering model but are likely to end up confusing investors and forcing them to start “selecting” the best scheme from a mutual fund house – most investors may not be equipped to make this difficult selection.
    3) In addition to offering investors a low-cost, simple product, the Quantum Long Term Equity Fund also endeavours to focus on a disciplined and structured investment process that follows the “value” style of investing which tends to shun today’s “popular” shares and buy those shares that have, in our opinion, a better risk-reward return potential.

    Quantum AMC was not created to primarily focus on rankings in terms of asset size or short term performance but was set up to provide a long-term investment vehicle to cater to investors who wish to achieve risk-adjusted returns over the long term

    Performance analytics is a very unclear science and, in addition to the adage that past performance is not an indicator to future performance, the science of calculating risks taken to achieve a certain level of return is far from perfect.

    We recognize that there will be investment opportunities that we may have missed in the past and many “I wish I had bought those shares” hindsight statements and we continue to endeavour to improve our research and investment process.

    Overall – since our Inception on March 13, 2006 – we are happy with our progress as a low-cost, long-term investment vehicle to cater to those long-term investors who wish to enjoy steady risk-adjusted returns over the long term.

    A few explanations from our side:

    About Expense Ratio
    For our Quantum Long Term Equity fund, the expense ratio of 2.50% calculated on our AuM of Rs. 37 crores, would amount to Rs.0.92 crore.. Whereas in case of HDFC equity with which you have compared us, at 1.8% calculated on an AUM of Rs. 4,600 crores, the expense works out to Rs. 83 crore. You can imagine the returns the investors could get if even a portion of this money were to be invested by lowering the costs. At Quantum, most of our expenses are of fixed nature and hence, even as our AuM increases, the expense ratio will drop and not remain pegged at 2.5%. (source: Valueresearchonline.com Fund Card Dated: July 31, 2007)

    For instance, when our corpus reaches a value of Rs. 300 Crore, even if our expenses double or for that matter even triple, the expense ratio would still be a lot lower than 1.8%. Other AMCs – built on a distributor-led buy-the-investors-money probably would need to continue recovering the higher fixed costs even with the AUMs rising to say Rs 4,000 crores.

    The Quantum Long Term Equity Fund now is paying for all its expenses on a standalone basis, and since most of our costs are fixed, we should be able to reduce our expense ratio over a period of time, once we get a core & stable corpus. We don’t have the data but maybe you can help confirm that with a corpus of Rs 37 crores, we must be the lowest break-even fund in India – that level of assets where the fund pays all of its own expenses. So any asset growth above this should be seeing a decline in expense ratios.

    Low cost to investor, is our core philosophy and we believe that the benefit of the same will accrue to the investor over a longer period of time (power of compounding). You are correct in saying that we do not have an entry load, however the exit load is charged to discourage investors from early exit. Till date we have retained the proceeds of exit load within the fund for the benefit of those who have remained invested.

    Low cost and lower expense ratios are a fund philosophy and is not in any way connected to the investment management style. Our example which you referred to in the blog shows how two funds with the same returns over a similar time period , will perform for an investor because of a low cost approach.

    Yes, we wish the performance numbers were better and – looking back to June 2006 – we wish we had bought some more of the stocks that did do well and less of the stocks that did not do as well in the near term. But, Deepak, that is our approach: we tend to buy stocks with a 2 to 3 year view. Many stocks we own may look like “dead money” for now.

    As you may have analysed, much of the rise in the Index since June 2006 has been due to a few stocks. Many of those stocks did not meet the “value” investment criteria that we adhere to. Hence we lagged the Index – and those peers who own these “growth” stocks. We are not certain what investment criteria other fund managers follow or whether there style is superior to ours or not – as you correctly pointed out, every fund manager has his day in the sun. But what we do know is that our “value” style should, over longer periods of time, give investors a decent return for the risks we take.

    Deepak, it may also interest you to read about the efforts of groups like MorningStar who are trying to work out a return Index that shows returns linked to when the bulk of money actually comes in to a fund. Performance metrics are still evolving and risk assessment models still fail to capture the qualititative “risks” associated with investing in companies and their stocks. Also, many well known investment gurus have written that performance numbers mean little but investment processes and investment philosophy is what you should invest in.

    We will continue our efforts of focusing on keeping our costs low, having a long-term investment discipline that we can always rely on, and ending up with a portfolio that gives investors decent risk-adjusted returns.

    Thank you once again for writing about Quantum.

    Regards,

    On Behalf of Quantum AMC,

    Nagesh Pai

  • Deepak Shenoy says:

    >Nagesh: Firstly, thanks for writing in and for your detailed reply. I would like to say that I admire the Quantum philosophy, and I have only been dissappointed by the expense ratio and exit load (given that the US funds such as Vanguard tend to not have such loads) Let me respond to your points one by one.

    While you do have just one scheme – QTLEF – and you expect to maintain just one scheme over time, I would personally, as a person who invests and tracks in funds, be more interested in a basket that still makes sense for the long term investor. For instance, having an index fund that tracks the Nifty is a veyr low cost measure (doesn’t even need a fund manager). Another example is a balanced fund where you maintain the balance so I don’t have to keep tipping things over as equity rises or falls.

    As for exit loads: You might have as well created an ELSS scheme. There needn’t be an exit load, the investor just cannot exit before 3 years. And, he would get a tax benefit as well. That’s hindsight, but even now, doing an ELSs scheme makes sense.

    You had said that most of the returns in the last year have been in a few stocks. I would beg to disagree. Other than a few stocks, nearly all stocks in the midcap and large cap space have risen considerably. At the value research online page for your fund http://www.valueresearchonline.com/funds/portfoliovr.asp?schemecode=3181, your portfolio P/E ratio is 27.16 – not a traditional “value” kind of ratio. If you are ok with high P/E stocks (I don’t question your picks, I just say it’s not pure value) then picking up stocks which made huge gains in the last one year should not have been a problem.

    In any case, I don’t grudge you the returns; every fund manager has his day. Yet, when you tell me in your July newletter that I shouldn’t bother to look at your one year returns because BEFORE THAT, during the downturn, you did well, I feel my intelligence is being scoffed at. It’s just wrong.

    Expense ratio: I don’t know why you (or I) would bother about 83 crore expenses for HDFC versus 1 crore for you. To me all that matters is how much percentage of MY money is not getting invested. You will agree here, that as a percentage, HDFC charges me much lower than you do currently. While it may change as you grow upwards, and the percentages may come down, I would rather SEE it come down first. You see, otherwise I will simply pay more until you get more funds, a factor I cannot control.

    Btw Benchmark’s Nifty BeES is much lower cost = they have a 1000 cr. AUM and expenses are 0.3%.

    While I understand you retain the exit load in the fund, your exit loads take away from systematic investments. Meaning, if I try to invest in a fund on a monthly basis – as most salaried people do – I will never be able to count on you for money that I need urgently. And what is investment, other than saving for a rainy day? Even if my rainy day comes 10 years later, 20% of my money is locked under a heavy exit load for two years, although I have been a great investor for 10 years. You penalise me for my needing my money when I do – the first two years is fine, but subsequent years in inexcusable.

    Performance analysis wise: The one measure of risk/reward is the sharpe ratio, which again makes sense only as a comparative measure. If you were able to give these statistics: Standard deviation, sharpe ratio, maximum drawdown and compare that to just the index, we might be able to evaluate you better – from both a risk/reward and also as a Pure reward perspective. I’m usually skeptical of measures that use data that is not in the public domain, like using input criteria such as fund flows which are not available to us (other than on a monthly basis) .

    Thanks for writing in, and I wish you all the very best.