Mutual Funds and IPOs: Time for a re-think?

livemint.com:

list of funds that bought the stock as anchor investors, you will find in that list a large cap fund, a small cap fund, and a mid-cap. And this is over and above categories like multicap, special situations, retirement savings among others! It appears that mutual fund mandates are just “fine print" and not really something that stands for anything.

How could all these funds be buying into the same racy IPO! I know, I know, the guidelines probably have some wiggle room but I would be horrified if I as a conservative investor in a say large cap fund, found myself as an investor in a 100 P/E IPO small/midcap stock! Second, is the argument that is being made by supporters of this move that the allocation to such IPOs is very small. In any case, mutual funds have done well over time, so we should cut them some slack for investing in such racy IPOs.

These views, in my mind, are rooted in ignorance and expose the other pitfalls of this move of investing in racy IPOs. Take the point about a small allocation.

Did the large cap fund which took money from you, take explicit permission that they will punt with your money, small amounts at a time, in racy IPOs of loss-making small and mid-size companies, with little visibility of sustained profitability? Giving them the benefit of the doubt that they are experts and doing a great job, well, just smacks of complete ignorance. You see, the mandate of the mutual fund is not go to out and make a return no matter what.

The aim is to follow the mandate and deliver what the investor signed up for. If sheer performance gave everyone a pass, a lot of the scams in the stock market would pass with flying colours! Next issue that comes to my mind is the fact that mutual fund managers are always