Why performance of mutual funds is poor

What are the possible reasons behind the poor performance of our mutual fund (MF) industry? Why are the MFs being less attractive with 41 closed end mutual funds? Why is a sophisticated industry in developed and emerging countries still in its nascent stage here?
This writer has seen many research works (mainly academic) on the mutual fund industry performance. But what is the point of such research if those research works can't contribute to educate investors in such a retail-driven market? Countless advertisements of training courses on fundamental and technical analysis have been seen, but why don't we see any training on awareness of mutual funds or better fund management? Is it again the deficiency in our education on financial system?
The concept of MFs appears to be critical and difficult to understand by majority of the people. For instance, many people are talking about the offer price or face value of MFs instead of their net asset value (NAV) while they get listed through Initial Public Offering (IPO). This lack of financial literacy definitely creates distortion in the market more than anything.
Overall market sluggishness has been perceived as the key reason of poor performance of MFs. But in recent times, it can be observed that even though DSEX rallied up to 11.4 per cent in one month (January 2014), MFs still fail to attract investors' attention on a decent scale. There is simply no demand and as a result a significant number of MFs are still in discount to their respective NAVs. Not only that, some MFs have shown a drop in their NAVs at market price on a weekly basis where it should have been on a rising trend. This actually calls for a question-mark about the level of skills on the fund managers' part.
Majority of the people view this market as a place for short-term money making. You invest, you get return within a couple of weeks and then you exit. However, that is not how it works. We firmly believe that one needs to have patience to generate alpha. Say if a mutual fund is 30 per cent discounted to its NAV, theoretically, it should be a good long-term pick given that the fund managers are skilled. But since, investing in MFs requires a longer horizon i.e. a long-term approach (say 5 years), the myopic investors are less interested. This is reflected in the trading volume of MFs. The liquidity is not up to the mark. For instance, on February 5, 2014, the turnover of MFs represented only 2.1 per cent of the total turnover.
Another source of loopholes is the lack of transparency. MFs are not mandated to make disclosures of their holdings and their underlying financial health. Our fund management industry just reports NAV at cost and market price on a weekly basis. But a prudent investor can always question if that reported NAV is reliable at all. As a matter of fact, a popular local daily, reported large discrepancy found in reported NAV by the Investment Corporation of Bangladesh (ICB) a couple of months back.
Again, also most of the fund managers have been on a safe side after the stock market crash using their full allowable limit of 40 per cent as cash position (e.g. FDRs). Now if the investors' sentiment is positive about the overall market, why would they invest in MFs and miss out the opportunity to participate in a rally? Simply there is no incentive. It involves opportunity costs too. Fund managers might reshuffle their portfolio when the right time comes but we don't think it will be that piece of a cake. The change in strategy will be lagged and will obviously involve considerable amount of transaction cost.
Another reason for our underdeveloped mutual fund industry and probably the most crucial reason is that there is simply no incentive to manage a fund with the best effort. A firm receives a certain percentage of the asset under management as a management fee. Regardless of the status of the fund, the fund manager will receive this fee.
In other countries, in addition to the management fee, an incentive fee is also involved if the fund's performance exceeds a certain predetermined benchmark performance. This actually motivates a fund manager to perform better and to take part in active management. Since there is no such arrangement in our fund management industry, fund managers don't feel the urge to exercise their expertise to the best possible use and take 'necessary' risks.
Mutual fund sector of Bangladesh is very small compared to that in developing markets in the neighbourhood and those developed across the globe. It is representative of only around 2 per cent of the total market. As far as the growth prospect of the fund management industry is concerned, it does not look that bright unless some effective authoritative steps are taken. Where the existing MFs are well discounted to their NAVs, new funds will simply bleed from under- subscription and thus inadequate funds. So  the solution to these problems is taking a long-term healing approach and the following steps can be followed:
*  Level of professionalism of fund managers should be addressed.
* The reported NAVs need to be vetted by a third party trustworthy organisation.
* Training programmes raising awareness regarding the MFs can be introduced.
* Investors need to develop a longer-term mind-set while investing in equity markets.
* Disclosures need to be mandated.
* Financial literacy needs to be promoted.
The writer is an analyst in the Asian Tiger Capital Partners. [email protected]