Fund managers' Catch 22: Doomed if you buy, doomed if you don't

Moneycontrol BureauStock prices are racing north, but it is not a happy time for an active fund manager. According to market experts, much of the money flowing into emerging market equities is coming through the passively managed exchanged traded funds (ETFs). ETFs track an index or a basket of stocks/assets. ETFs are gaining popularity because they are traded on the stock exchanges, are more liquid, see greater price swings and charge lower fees. Conversely, actively managed funds select stocks based on research, charge higher fees and see a gradual change in their net asset values on either side.In a rising market, usually investors flock to mutual funds creating a problem for fund managers, especially those managing active funds.When the market has been rising for a while, valuations turn expensive. Frontline stocks may look a safer bet, but much of the action would be happening in midcaps. So the fund manager will have to either invest in large cap shares knowing that the gains will be muted, or invest in the risky midcaps, knowing that the fall could be equally steep when the trend reverses. More often than not, fund managers choose the more volatile midcaps, hoping to boost the net asset value of their funds, and draw more investors. Not investing at all will certainly draw flak from the investors, who feel fund managers should be able to spot the best opportunities for the fees they charge.Swift rises are invariably following by an even swifter fall when the mood changes for the worse. That mean fund managers will have to dump the more liquid frontline stocks than the midcaps where liquidity would have dried up. This will further hurt performance, as the good stocks will be out of the portfolio and unsold junk will continue to melt away and bleed the net asset value.During the bull run of 2007-08, equity mutual funds in India had witnessed a record monthly net inflow of Rs 13,700 in January 2008. A similar frenzy was seen in 2015 as well. So far, 2016 has not been kind to equity fund managers  despite the spectacular rebound from the March lows.Net inflows into domestic equity mutual funds during the first half of 2016 at roughly Rs 13,500 crore are down 75 percent compared to the same period last year.Kotak Institutional Equities’ Sanjeev Prasad sums up the mood in the fund management industry pretty well.Excerpts from an interview to CNBC-TV18 earlier in the day.“It is pretty painful at this point in time in the sense that you have a bull market in a way, but you are not getting any new money to manage. If anything, you are struggling to retain whatever funds you have got at this point in time. So, it is a weird kind of bull market where I do not think anybody is really happy with the appreciation in stock prices. You are feeling very uncomfortable about valuations. Whatever fundamentals you have may have in terms of a fair price range for a stock, it has been breached sometime back. And you are forced to hold on to the stock, because you really have no option.”