Why blindly chasing fund managers investments may land you in trouble?

Why blindly chasing fund managers' investments may land you in trouble?

A couple of decades ago, many investors asked for hard copy of funds' factsheets. Those were the days when the internet was not as widespread as it is today. The first thing they would do is to check portfolio of mutual fund schemes. If a fund manager bought something new, they would sometimes buy it and try their luck. Today, the digital world has made life simpler. Information flows fast and free. Moreover, media and brokerages release reports stating new purchases and exits of star fund managers. And there are investors who want to buy stocks bought by fund manager they look up to with a view to make some quick buck. But seldom this strategy of chasing star fund managers has worked for retail investors. Let us understand this in detail:

Portfolio Diversification & Weight

Most investors simply look at what was bought in the last month. But they tend to ignore that a purchased stock is a small component of a diversified portfolio. A scheme’s portfolio may have 50 or more stocks and the weight of a stock may be miniscule. However, if an investor has allocated a large part of her capital then she may be taking far more risk than that the fund manager. The investor also does not know if the fund manager has completed his purchasing. The fund manager may have bought a token quantity and may want to buy more of that stock on price corrections or when the company achieves some milestones. The investor however may use all his capital in the first purchase itself. This may prove counterproductive. Most small investors cannot build stock portfolios for the long-term using this strategy.

Price of entry and exit

Generally, equity schemes’ portfolios are disclosed at the end of the month. This does not offer any insight on the price at which a fund manager has bought the stock If the price has moved a lot till the time the news reaches the general public, then there is a risk of retail investors buying a stock at a far higher price than a fund manager. Also, there is no clue when and at what price a fund manager intends to exit a stock. Though most mutual fund managers buy a stock with a relatively long term in mind, there are situations wherein stocks hit their target in a short span, compelling them to sell.

Time-frame

In most cases investors have a limited amount of capital and they have time constraints as well. An investor's timeframe may widely differ from that of a fund manager. For example, a small investor may want to try her luck with some money in six months, but a fund manager may expect the stock to deliver over more than five years. The fund manager may be mentally prepared to buy a stock in instalments over the next one year. In that case, the stock may not move, and an investor may not make money if she follows the fund manager's investment pattern

Churn & Taxation

Sometimes fund management strategy is such that stocks are bought and sold at frequent intervals. Most investors will find it difficult to follow these transactions and manage quick entry and exits. This also leads to costs associated with churning and short term capital gains, if he makes money. A fund manager, however, does not pay taxes. In that case, investors’ returns are going to be lower than that of a fund manager.

Risk Profile

Fund managers not only rate stocks based on expected returns but also on the basis of risks they perceive. Most investors pay no heed to this aspect. High risk stocks are bought by fund managers with clearly-defined exit strategies and accordingly they are allocated money. Most small investors have no idea of this. They may not have the requisite risk appetite to invest in such a stock.

On the whole, investors must understand that the world of stock investments is such that a star fund manager of the last year may start underperforming in the subsequent year. In the long term it is the exposure to an asset class that matters for most investors. For example, even if you buy the frontline index such as the Nifty 50, and hold it for a decade or so, you are bound to make money. But if you buy a dud stock, then there is a risk of permanent loss of capital.

All these factors make it clear that the small investors are better off investing in mutual fund schemes than chasing the stock ideas of the fund managers. Investors should rather handover their money to professional managers. Diversified equity funds can reward investors in the long term. Investors can also look at mid-cap equity funds for superior returns. Always use a systematic investment plan to invest in equity funds.

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Disclaimer: This report is prepared in his personal capacity and neither the Author nor Money Honey Financial Services Pvt Ltd assumes any responsibility or liability for any error or omission in the content of the article. Investments in mutual funds and other risky assets are subject to market risks. Please seek advice from an investment professional before investing.

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