Cafemutual caught up with John Rekenthaler during his recent India visit for Morningstar India 2012 awards to get his perspective on the star fund manager culture, ratings accuracy and more…
John Rekenthaler
Unlike US fund managers, Indian fund managers are able to beat their benchmarks. Why is it so?
The Indian market is younger and under researched than the US markets. The Indian market offers an opportunity for the active fund managers which US market doesn’t. There are not so many large Indian investment managers. I would expect that the opportunities may decline over time as the Indian markets mature and more institutional investors start looking at India. It looks like a good place for active fund managers right now.
What is the role of individual fund management skills versus organizational processes? What is more important according to you?
I think they are both important. Sometimes a fund succeeds because the individual fund manager is skillful and it has nothing to do with the organization. Sometimes if a fund manager leaves the fund completely changes. Other times the organizations providing robust processes, in depth research help funds succeed. If the manager leaves it doesn’t matter. Sometimes it’s in the middle. It’s hard to generalize. Ideally, it would be both – exceptional fund manager skills and sound organizational processes. In such a case if a fund manager leaves, the organization is able to handle the situation and the fund continues to perform well.
Have you come across a situation when a star fund manager has left and the fund has suffered due to it?
Not so much recently. These days when a star fund manager leaves investors tend to be patient because there have been a number of instances where a star fund manager has left and the new fund manager has done well to keep the fund together. The mindset has changed among investors. It is more of organizational mindset now. The star fund manager market was prevalent during 1980s. Now it’s an organizational market.
The Indian regulator has expressed concern over rating companies giving awards to funds. What is your perception of this alleged conflict of interest?
We don’t have these issues in the US. I am not saying that the Indian regulators are wrong. It is something for us to consider. We will think about it closely. We would like to be on the same side as the regulator. Both regulators and we represent the investors. Our clients get to see all aspects of the research reports.
Indian fund managers don’t follow a particular style of investing like growth, value etc. How do you categorize funds in India in your style box?
We look at the characteristics of the portfolio. When we assign a designation to a fund, we don’t ask the fund manager. We look at the stocks held by the fund. We study the three year style of the portfolio and assign it as value or growth. We will put the fund manager in value category even if fund manager calls himself a growth manager but invests predominantly in value stocks.
Are investors in US conscious about the style followed by a fund manager?
In US these terms are very well known. People think of how much money they have in one style versus the other. In some markets growth stocks tend to be up 20% and value stocks remain flat. So there are a lot of differences between them. It is considered as important as large companies versus small companies. We understand that these terms aren’t necessarily applied everywhere in the world.
Is a large fund size detrimental to a fund’s performance?
Yes it can be. It is difficult to know when a fund becomes too large. We don’t know how to measure that exactly and nobody else does either. The only person who knows is the portfolio manager. It is difficult from outside to know when a fund becomes large. We have seen such instances in the US where the performance has gone down.
Have you conducted any study to evaluate the accuracy of your ratings?
In US we evaluate the funds over a five year period. They are moderately predictive. Five star funds tend to give higher returns than the four star funds which tend to have higher returns than the three star funds. It’s a fairly narrow range. The US market is quite efficient. In India we analyzed three year returns and the pattern was stronger. It’s the same reason why active fund managers are doing better in India. The ratings tend to do better in India than US.
Have you seen that higher rated funds tend to get disproportionately large inflows?
We did a study when we looked back at the US markets in 1990s before the Morningstar did not even exist to look at what ratings we would have assigned funds. We observed that the money was flowing into four and five star rated funds. People like funds that perform well. Yes you do see that money flows into top rated funds but that doesn’t mean that it’s because of Morningstar’s influence.
The regulator banned entry load in mutual funds and the fund companies and advisors are having a tough time ever since. Would you like to share some international experience regarding front loads?
In European and many other markets there is no front end load. Some funds have a front load but they don’t charge it because the investor or advisor negotiates and the advisor is paid based on the trail. In Canada there is almost no front load and the advisors are paid on the trail. There are many markets that are like India and they function very well. I think India will have no problem in figuring it out on how to pay advisors and make it work. Even in US most funds sold by advisors don’t have front loads and they are paid by some other arrangement.
