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What To Do About The In-Fidelity?

Fidelity Mutual Fund has decided to exit ops in India, presumably on six years of no profits. They manage assets of 8,800 cr. and there were a lot of posts talking about how this is a huge negative for India and how this is because of SEBI’s regulations etc.

Total. Horse. Shit.

First, if they have been losing money for six years, it’s not because of SEBI’s regulations. SEBI allowed funds to charge investors entry loads till 2009; there were other onerous charges like “NFO marketing costs” that funds were allowed to charge even earlier. If they couldn’t make profits then, chances are SEBI isn’t the one to blame.

Second, other mutual funds have been making money. The most profitable are HDFC and Reliance, but even the tiny Quantum is making profits. There’s no reason to think the industry is in doldrums. It’s in flux, yes. It’s in play, to consolidate, to realign, yes. But not in the pits.

Third, what rules has SEBI changed recently? Mostly the entry load and commissions. Srikanth Meenakshi of fundsindia.com reminds me (on the quora board) that Fidelity has most of its money in the US in no-load funds (more than 93% of assets). Management fees are just 0.85% in the US (India’s limit is 1.25%, which applied even before Fidelity got in)

Lastly, there are many fund houses that keep wanting to exit. When Merrill went crying to the arms of BoA, DSP-ML became DSP-Blackrock. Lotus exited its funds to Religare. Benchmark sold to Goldman. The point is that getting out is normal – there should be nothing more to read into it other than that Fidelity didn’t have the stomach for the fight anymore, which is fair in the world of business.

I don’t know why they allow such a rumour to spread that they are leaving due to low profitability. Who the heck will pay big money for their funds? Anyhow, people are going to be willing to buy. Typical deals are 3-4% of assets, but we’ve recently seen many with over 6%.

What should you do if you own a Fidelity fund? Well, stay put, there’s nothing wrong with the fund. Would you sell your Infosys shares if Narayan Murthy sold his? All that’s happening is that the owner of a fund is changing. The employees, the fund managers etc. are likely to continue. What you should care about though is that if enough people exit your funds – to take the assets of the fund to less than 100 cr, for instance – you might consider leaving as well.

Update: You might want to consider exiting if the fund management team is leaving as well. More in this post.

And don’t go by the hullah in the press. There’s nothing spectacular about Fidelity leaving.

  • S says:

    I totally agree.
    This article is an example of the Hulla that is going on with regards to Fidelity’s exit:
    http://www.moneylife.in/article/fidelitys-exit-a-slap-on-sebis-face/23340.html
    BTW, I really hate this Moneylife magazine. Most of their articles do not seem to make sense at all.

  • Anon says:

    Agree completely.
    Fidelity’s problems were their downright arrogance and incredibly high and inflexible cost structure.
    SEBI’s rule changes only brought this into sharper focus.
    Nobody seems to highlight that.
    Give the same kind of asset base and product mix to another management and they’d be profitable – trust me.

    • What was the issue with their cost structure? I.e. were fund mgrs given high salaries and not linked to AUM or something? Arrogance – yes, I remember them telling me when I was pursuing a distributor business that they weren’t bothered with individuals, only wanted to sign corporate distributors. Their funeral, I guess. 8800 isn’t very small AUM, I agree that if someoen else had it they’d probably go leaner and turn it around fast. Would be fun to see the “boohoo” articles response then 🙂
      As for the rumour about Fidelity leaving because they weren’t profitable – I suppose the best way to put it is, if you can’t face the heat, get out of the kitchen….

  • Deepak Singh says:

    I think we need to see from a different perspective. The big question: SEBI should do impartial and objective exit interview to understand the reasons why a big fund company is not able to survive in this country. I am sure some fault lies with Fidelity but to say that it’s all their fault may not be right. CB Bhave as a SEBI chairman destroyed this industry. It’s high time that SEBI should examine all issues at hand.

  • Anon says:

    Deepak
    Always enjoy your forthright views; have benefited too from several informative posts. Being from the industry, wish to be the devil’s advocate!
    First, Fidelity costs were too high and probably fund managers exorbitantly paid and continuing loss is not acceptible – completely agree
    However, unlike some financial products (equity), in the case of MF, the ‘manufacturer’ has interest in a continuing and enduring relationship with the ‘buyer’. This is nurtured first by proper returns and very importantly, by SERVICE. Let us call it ‘after sales service’. This is where Fidelity excelled and was streets ahead of other players – esp. the top 10. No doubt the MF industry is evolved and consumer issues are very few for an industry this size, however it is a fact that Fidelity offered the best service to retail ‘customers’ and this may have come at great cost
    You must be aware that about 70% of the Fidelity AUM is from equity and this not by unnecessary NFOs and we will miss a fund house of this calibre and service. The new owner ‘who has the stomach for a fight’ will certainly fight to double AUM – after all their valuation will depend on their AUM
    Regarding the Regulator: Yes SEBI has taken great measures and has curbed misselling. But even if outwardly most financial writers agree with SEBIs ways, the industry growth has been stifled. Well ,entry load and upfront were abolished, but a transaction fee introduced Rs. 100 to 150 !! My view is that the decision was too hasty and that all stakeholder views were not taken into account properly.
    4. Industry in slow mode: Would request you to check next year – compared to 2010-11, the number of official points of acceptance WILL COME DOWN, since AMCs will not increase costs – unless we have a great bull run and investors jump in as always only during market highs. Investors in smaller centres do not use online means to transact and a point of presence is reassuring to local populace. What I’m getting at is that citywise expansion is slowing down, infact contracting. What a pity, for MF is the best available product for small investors
    It is great to read your views and keep them coming…

    • Anon says:

      To categorise Fidelity’s customer service as “streets ahead” would be a misnomer.
      I think the MF industry has been largely good at customer service. I havent found much difference between the service offered by one fund house (say Fidelity) from another one. There might be several chinks still to be ironed out (like online transaction access etc….), but given the SEBI stipulations like KYC, time stamping etc. one gets the general feel that the industry is upto the task.
      And just to remind you Fidelity is possibly one of the least transparent of fund houses. Given a choice they wouldn’t like to reveal their portfolio or discuss their performance at all.
      As for the SEBI rule changes, yes they have used the sledgehammer and severely affected the ‘last mile’ reach to investors. However the fund industry can not absolve itself of any blame. It should have seen this coming.
      Outright misuse of norms that previous regulations allowed (e.g. amortizing the initial spend on new fund offers etc..) was what eventually forced SEBI to take such drastic action. Granted it was only a few players that probably indulged in such activities and with intense competition others were forced to follow (just like you – i speak as someone who’s long been associated with the industry).
      This is where the industry association AMFI (which even today is run as a cabal – much like BCCI) should have stepped in. On the contrary AMFI was (and is still being) used to perpetuate unsavory practices. In the end the industry has got what it asked for – by its actions.
      Do some rotten eggs spoil the whole basket? They do. The whole industry got painted by the bad name that only a few deserved. That’s how life is, isn’t it?
      Having said that, I’m not one to shed any tears here. The industry and its associated players like the distributors have to adjust to the new reality. Margins will shrink, and the easy money will not be forthcoming. This is a normal process that any industry goes through. The only way to survive is to have a consistent focus on performance and innovation.
      Finally, the ultimate customer – the investor – also has to realise that there is no free lunch and good advice comes at a cost. I hope that eventually investors would come around to paying for sound financial advice.

    • Thanks Anon – I don’t know about Fidelity’s costs in India honestly, I assume that is a small problem and can be fixed easily. I don’t know if after-sales service was exceptional – I have invested in MFs for a long time, and I have had exemplary post-sales service from everyone – from HDFC to HSBC to Canara Robeco to Franklin Templeton. The service levels are largely handled at the CAMS/Karvy level, and even Sundaram which set up its own RTA has given me good service. I wouldn’t think service is what should make Fidelity stand out. I haven’t invested in a fidelity fund but honestly I wouldn’t move to it for “service” – would do so for performance. (I would though love to know how they differentiated based on service – in my experience most of the large MFs including Reliance and UTI have handled customers well)
      I remember Fidelity became big in the US based on perseverance. The most investor friendly house was Bogle’s Vanguard, which transformed the US MF industry. Fidelity lived through that. Fidelity had great fund managers in the past, and they have shown phenomenal performance.
      Transaction fees of Rs. 100 to 150 – I think that makes sense because that is the petrol cost to submit forms 🙂 Beyond that, it’s just advice, and I would charge for advice. I know this sounds alien, but we have to do it.
      I don’t disagree with the official points of acceptance piece. That has to be addressed in every field – banking, MF, etc. and it is really not supposed to be a high cost operation. The problem is that it doesn’t happen overnight, like it happens in cities, and we need to take the time – even if it takes 10 years, the idiocies of the past (remember UTI 64) aren’t going to go away from rural or semi urban memories, so we have to build confidence in these end-points rather than use big commissions to attract shady distributors. For ex, a better use of cell/internet to a distribution center (fundsnet can do this right now for MFs, NPCI-base for banking) can easily set up a contact point in a remote area, for document validation, upload and transaction processing, with little or no loss of compliance. These places, though, have no power, so we have to search for (and will likely take years to get) solutions that can be run off low power batteries. I think small investors are important but if we persist they will come, but in a situation like now when we are in flux, there will be tremendous uncertainty.
      I must thank you enormously for the compliments 🙂

  • Milind says:

    I think service is very important. Not sure, if you used to invest in SBI MF in Sandeep Sabarwal days (2003-2007). Even though their performance was good, service was really bad. Same is case with UTI.. I feel, Fidelity and like them (MNC MF Companies) are good at that. Whatever best UTI Funds do, I will never invest a dime in it. (Call it service bias). I found some fund companies used to pay dividends within fortnight and some used to take months to get either credited using ECS or Direct Credit or Cheques. Now a days, these things are not common due to strict rules.
    Regarding cost structure, I think only Indian unit will not bear the cost of equity analyst team and may be international units also bear some of this cost as it helps to garner some AUM outside India through their International funds.
    Also, MNC AMC’s must be paying higher salaries, first to attract talent when they are setting up shop here and that might not linked to AUM or performance in initial years. Look out the famous fund managers and their moves. Its mostly new fund houses.
    I feel investors should slowly move out of fidelity funds ( not a knee jerk reaction) if they are not comfortable with this news or new owner ( say if Sahara buys out Fidelity in future) by looking at tax rules, exit loads etc..
    Disclosure : Approx. 3 % of total MF Exposure to Fidelity

    • Milind: I have SBI Magnum Global and SBI Magnum Taxgain in my portfolio for years (though some have been sold). I haven’t had an issue getting dividends (in the Taxgain) through ECS, and not an issue selling either. Have suggested it to a lot of people who haven’t gotten back to me with a service complaint.
      I think we will probably disagree about moving out of Fidelity – but the thing to watch, also, is fund managers, will they leave the fund?

  • Manoj Nagpal says:

    I attempt to puncture holes in your story and I hope you will take it in the right spirit.
    Your Arguments / Points are contested as below:
    Argument 1.
    SEBI previously allowed NFO Marketing Costs: Never, ever was there a head of NFO marketing costs. The big change was that close-ended funds were earlier allowed to amortise expenses which was stopped by SEBI. Fidelity was not in the close-ended space. With the stopping of amortisation in close-ended funds, the category died and rightly so! For open-ended funds nothing changed except the entry loads in Aug 2009
    Argument 2. Even Quantum makes money:
    You are right Quantum MF in 2011 made a PAT of Rs. 5 cr on an AUM of sub Rs. 150 cr. Wow one would say!! If you dig deeper, they have a gross income of around 17 cr. Of this 1 cr is for domestic mutual fund operations, 12 cr for providing research services to its other offshore entities and 4 cr other income. So at best Quantum operations can be said to be a Research house making money and the not mutual fund operations. Can’t take away the fact that the larger ones (Top 10 fund houses) do make money.
    Argument 3. Internationally Fidelity has 93% of the funds under no-load:
    No-load is not the problem but the skewed structure in India that even under no-load funds a fund house pays a commission of atleast 0.50% upfront and upto 1.25% upfront to larger distributors. Remember, Fidelity only worked with the larger distributors. This is not the case in US, no-load means no upfront commissions and also fund gets to charge a 12B-1 fee in addition the regular fee. Secondly the trail in US is 25 bps but in India at the lower end the trail is 50 bps and a larger distributor is at around 75-100 bps of trail. Again remember, Fidelity works with the larger distributors. This model was alien to Fidelity and they were not willing to customise to local conditions.
    Argument 4. Other funds also exited India earlier. Big deal! :
    The difference this time is that the Fidelity is not exiting because of a good valuation or pressure on its parent or an exit from Asia or any other global strategy. Every sell out in the MF industry in India has been due one of these reasons till not. Fidelity wants to exit India because it believes that the Mutual Fund opportunity in India is not exciting/profitable/viable on a long term basis. They have raised two primary questions: 1. Will the MF India story realise it potential? (Remember their vision: To be a USD10 bn fund house by 2010 in India and they are still sub USD 2 bn)
    2. How long till a MF in India can make money from its local operations? They set up base in India in 2004, launched their first fund in 2005 and so have been in India around 7 years and nowhere closer to breaking even locally. And for providing india research to its offshore funds/fund management, they don’t need an India local operations.
    So the moot point they state is that, they or any other newer fund house in the current environment and format of business, cannot make money in India from local operations for a long long time and its better that we exit. That’s a message lot of new players and the regulators may/should listen to.
    Argument 5: Rumour on low profitablity. But Lot of buyers!:
    Accumulated losses of 300 cr plus, annual losses at rate of 60 cr, high cost of operations and need to pump in capital even to sustain business. Its NO rumour but obvious, they do not want to pump any more capital into a business where they don’t have visibility on profits. And you are right they will get a buyer in 3-6% band of AUM. And remember they are not selling the brand, not the team, no distribution presence to talk of, not a great distribution network except some large distributors selling. So in effect they are just selling the Assets and folios. The only positive is that they have a large proportion of equity AUM with a good track record. The track record without the fund manager is also valued lower during such deals (Remember the sell off of Alliance Mutual Fund without the fund managers, it got a low valuation because of this). So most probably the would get a valuation on the lower side rather than the higher side.
    Argument 6: Investor should stay put!
    They are only selling the assets though also exploring other options of strategic investor who can pump in further capital requirements in the business. All options open they say! That should be an alarm to investors. Fund manager won’t continue, philosophy of the fund may or may not continue, and fund managers may already be given additional responsibilities during the shift leading to low focus on India funds. Well the choice is the investors whether to stay put or move to another fund.
    Whew, I think I have written more than your original article. But then you do manage to write well and I ramble here and there. The point I am trying to make is that I agree with your view that only regulations are not to blame and lot of it lies within Fidelity but I don’t subscribe to the reasons you stated. You may say that it doesn’t matter ultimately we both have the same conclusion though the reasons may be different, but that’s where I differ 🙂

    • Thanks for your notes, Manoj, much appreciated! Let me also debate this one by one:
      1) NFO charges – Remember Reliance Equity Fund? It was open ended and it collected Rs 5000 cr. in 2005, of which around 300 cr. was used for marketing expenses, amortized across 5 yrs. All NFOs even open ended ones were doing the 6% expenses game. SO SEBI said only closed ended funds can do it. What happened? A slew of closed ended schemes like Reliance Equity Opportunities Fund came about. Then SEBI took it out altogether and everyone sulked.
      2) Quantum: You’re right about the fact that they get research and advisory payments, and perhaps we should remove that (however it’s difficult then to amortize salaries and other costs across each practice I guess). But Benchmark was profitable too and it has no entry load (not even the distributor payments since everything is exchange traded) and has very low management fees. It’s very strange that funds either find other sources of revenue or work their cost structure down and get profitable, while Fidelity didn’t. The argument of the airlines applies – the industry has nearly never been constantly profitable, and much of it is because of regulation, but there are still players interested!
      3) I had done some research on Fidelity US (after Srikanth and I had talked) and had found that they don’t do a lot of 12B-1 on their own funds – they do it for a few funds others list on their marketplace, but haev in the past credited back customers their retained portion of 12(b)-1 charged. Trail fees in India – if you hit the 1.25% mgmt fee I suppose you could do the higher trail fees, plus Fidelity was a little silly in not accepting small distributors that they could afford to pay lesser. They have operated in the past (in the US) under a high commission expected model also, IIRC.
      4) Lotus was a distress sale, no? I’m sure there are more – or will be, considering the sorry state of some of the smaller funds 🙂 Plus – they can be a $10bn fund – they need to get more into debt which is a bigger market here. Second, they aren’t breaking even for their own faults – Franklin Templeton has been profitable for a long time and they are a foreign firm as well. Lastly,
      5) 300 cr. losses itself is a valuation of what, 60-70 cr? SInce you can write off the losses with future profits that is. now 60-70 cr. is about 1% of assets (or will be, considering they will lose some assets). Btw, Alliance was 7% of assets, which is a pretty good deal. I guess the 3-6% is a pretty good deal after all the rumours, but it seems they’re targeting 7%. Let’s see how that goes.
      6) I think you have a point – if the fund mgmt is going, then there is cause for concern. I didn’t know that – thought it was just the AMC ownership. Perhaps then the idea is to take a look at who buys etc. But you bring in a strong counter – I must relook that “stay put” advice in light of the fact that fund manager and philosophy will change.
      I think you should write! Thanks for the great discussion – I have learnt a lot, and hope we’ll continue. No issues about comments being bigger than posts – the idea is to communicate, not a one way street!
      ALso perhaps there is a way to create regulation without puncturing some of the great things we’ve done so far (like removing entry load or ensuring fair practices for all investors). Awareness is one thing, but like I spoke with a friend recently, the problem of MFs is that they don’t usually tell people how they are better than other instruments like Debt. Maybe I will expand in an article.

  • Manoj Nagpal says:

    Your knowledge is indepth and it makes me retract my statements on point 1 and 5.
    And maybe you should be man enough and retract your statement “I think you should write!” because otherwise I may just take it seriously! 🙂

  • prabe says:

    My only wish is NOT to see SEBI bring back entry load.

  • Sachin says:

    Service are given by R&T agencies — Karvy/CAMS/UTITSL. So it doesn’t matter for RTA agent if the investor is of Fidelity or SBI or anyone else. Service quality will be same for all funds as it depends on the R&T person attitude you are dealing with.
    First comment say “I really hate this Moneylife magazine. Most of their articles do not seem to make sense at all.” If you disagree then why do you hide your name ? I think your “hidden” comment did not make any sense.
    Deepak, Liked your article as always and also learned a great with discussion in comments as well.