Mutual Funds seem to be seeking little 'value'

There are often talks that value investing worked many years ago when markets were less efficient. Now, with the amount of research that goes into stocks and the amount of new players that have entered the market, value investing has much less scope to unearth bargains. Or so the theory goes.

The chart that you are about to see next is one that will confirm to you that the above is nothing but hogwash.

But first, a brief primer on mutual funds. Out of the money that you invest in them, equity mutual funds hold a percentage this in cash. The rest they invest in stocks. A small part of this cash holding is out of compulsion, as they have to meet obligations from investors who seek to redeem their units from the fund. However, a larger part of this cash holding by a fund has a lot to do with how the fund manager thinks the markets will perform going forward. If he thinks that stocks will go down, he will sell some stocks and thus increase his holding of cash. Similarly, if he feels that markets will move up, he will by more stocks and consequently the fund’s cash holding will go down.

However, as the following chart shows, they can be quite bad predicting the direction of the market.

The chart plots the monthly cash holdings of the mutual fund industry as a percentage of their assets against the monthly low of the BSE Sensex for the past one year. The results are quite interesting to say the least. For as stocks got cheaper, mutual funds sold more stocks and increased their cash holdings to unprecedented levels.

So in effect, as Indian companies became cheaper to buy, Indian mutual funds were actually selling them instead of buying more of them. Quite the opposite of what they should have been doing. And this logic defying act was repeated by them on the way up too.

As markets have risen higher and higher in the last six months, and consequently stocks became more and more expensive, mutual funds have been buying them with full vigour. Infact, their cash levels have now fallen to extremely low levels once again.

Infact, cash holdings of diversified equity funds averaged around 5% to 6% of total assets in October-November 2009, levels that were last seen during December 2007 and January 2008 when the markets were at their peak.

Indeed. Buy high and sell low seems to be their mantra!

But that’s not such a bad thing afterall. It shows that most large mutual funds to this day commit the same mistake they have been committing for the last century or so. And in the process, they leave doors of opportunity wide open for those smart investors who realise that you should buy your stocks as you buy your groceries, not as you buy perfume. The cheaper the better.

Do not be surprised if markets tank sometime in the future and you see mutual funds selling once again. Just stick your neck out and look out for those bargains that will once again be yours for the taking.

Source: http://www.equitymaster.com/detail.asp?date=12/23/2009&story=5