Recent fiascos: What ails mutual funds?

And what should one do about the increasingly negative news cycle? But first, some background: over the last 5 years or so, there have been a series of reported incidents which have dented investor confidence in the asset manager’s (those managing mutual funds) ability to manage inclement market conditions and issues arising out of inadequate risk management.

The ball was set rolling first with the FMP crisis where the demise of IL&FS created conditions which resulted in Fixed Maturity Plans being no longer fixed: underlying bonds defaulted and in some cases maturities were extended much to the alarm of investing public. Situation took a turn for the worse when some funds were shuttered as bond markets froze up just as the Covid-19 situation was becoming increasingly alarming. Another year and change down saw a slew of insider letters and ‘whistleblowers’ alleging all kind of irregularities which had AMCs scrambling to issue statements to shore up trust in them and their processes.

The latest fiasco was the ‘Lamborghini-gate’ where the lavish lifestyle of a chief dealer and a fund manager led to their sacking and the regulator this time stepping up their investigations in front-running. But all may not be well. So, are mutual funds bad? The answer to that is a clear no as these are merely containers for strategies determined by fund managers with oversight by everyone from internal teams to regulators.

Despite all this, investors and investments into mutual funds have been at an all time high and returns have been good on the back of stock market rebound of 2021. Sometimes, mostly on account of poor controls, things do go wrong and anyone partaking in these needs to manage such risk. Few things to look out for are, as stated even by the SEC, first find your risk tolerance: do not get greedy or take excessive exposure to risky equities. An RIA should be able to help with this analysis.

Secondly, diversify across funds, across fund managers and across asset classes. Any failure in one part of the larger portfolio should not derail either financial objectives or broader financial plan. Should there be bad news, either in form of misdeeds or even the market sinking, a cool head will go far in reassessing personal risk and return expectations.

Therefore, any single investment should be looked at as a complementary component of the larger strategy. Remember all investment is necessarily for the long term and for future security – short-term knee-jerk reactions rarely bode well for a disciplined wealth creation. If, however, there is an imminent cash requirement, or will soon manifest (link impending retirement), a risky portfolio is not ideal: a conservative and defensive approach is advisable where both capital is preserved, and the income needs are met.

Last but not the least, wars, shortages, inflation, and spiking interest rates together have a way of panicking even most astute investors. We have seen all these apparent in the recent ongoing invasion of Ukraine coupled with draconian Covid lockdowns in Chinese cities.

But, like everything else, these too shall pass so the best thing to do? Stay calm. If you do not have a financial plan, make one and stick to it. The pandemic is not quite over yet and neither are the other factors roiling markets. While there is no way to predict the future of a mutual fund portfolio, a well-diversified approach, managed in a consistent disciplined manner will go a long way in protecting from any operational risk or other failures at mutual funds.