Fund managers are professionals responsible of making investment decisions regarding the selection of individual stocks and bond for a portfolio. The fund manager offers his expertise, his investment philosophy and a style of managing the funds.
Fund managers present themselves to the market as experts in the investment of certain categories such as large cap equities or mid and small cap equities or fixed income duration management or government bond managers and more; they may well define their goal as providing a risk-adjusted return superior to their benchmark such as equity indices or and bond indices.
Fund managers inform the public of their expertise and philosophy and invite investors to trust them with their investment amount. It is the investor’s responsibility to determine how much the portfolio to allocate to a particular asset class be it equity, fixed income or alternatives and the fund manager’s responsibility is to do a competent job of managing the funds in that class.
Fund managers are focused on implementation of their investment philosophy which is also known as investment guidelines. Their goal is to maximize return. They are an institution in that they expect to be measured against other fund managers in their asset class.
Mutual funds competitor for business by advertising their return usually relative to competitors or an index.
Equity fund management in mutual funds
The equity fund manager begins with his selection universe that could be any particular market index such as nifty50 or BSE-200/500 where he would track and perform analysis on companies forming the particular index.
The fund manager could be assigned stock within a specific sector such as banking and financial services or infrastructure or technology and so forth or could be assigned to create portfolio concentrating on certain geography such as United States, Europe, Asia or Emerging Nations. He could also build stock portfolio according to some style indices such as value or growth.
Investment guideline set by the fund manager is utmost importance to the investor as it details under what constraints the funds will be deployed and managed. It is then up to the investors discretion based on investors risk profile, objective and analysis whether to invest in that fund or look for some other schemes set by others.
Once the fund manager has selected his investment universe then he writes the investment objective of the fund as to what the fund manager is likely to achieve. The objective of the fund manager could be that he would provide capital protection to some extent or try to outperform his benchmark index by certain percentage or basis points in a given year.
The fund manager then sets the risk objective of the scheme as in where he limits his investment exposure to sectors, company, cash position, ownership in any company, exposure to type of securities and geographies.
There are two types of equity funds:
- Passive Funds
- Active Funds
In an active fund the fund manager tries to outperform his benchmark which is known as alpha with his experience of stock and sector selection using his knowledge of macroeconomics, fundamental analysis and quantitative modelling.
Whereas in a passive fund also known as beta, the fund manager does not try to outperform his benchmark but tries to replicate the benchmark performance. The fund manager has to mimic the constituents of the index companies with respect to same weight as the company holds in the index.
The scheme performance of index fund is judged based on tracking error. Tracking error is impacted by the inflow and outflow of cash into and out of the fund and the transaction cost for entering and existing the position of securities. The fund manager of index fund need to manage them well to keep the tracking error of his scheme low.
Index funds carry lower expense ratio compared to an actively managed fund.
Fixed Income fund management in mutual funds
The fixed income investment is done where the investor lends his money for a pre-determined interest rate and expects the return of his principle amount on the maturity of the issue.
Fixed income investing is based on tenor. If a security tenor or maturity is less than or within a year then these are known as money market securities, whereas maturity more than year are termed as bonds or notes. The issuers of these securities is the government or corporates. Government securities are known as risk free as they do not have a credit risk, meaning they do not default on their re-payments and interest where as corporate bonds are subjected to credit risk as chances of default of a firm issuing the bonds are higher. Interest rates of corporate bonds is higher compared to government bonds due to credit risk feature.
Fixed income portfolios are also managed as passive or actively. In passive, the fund manager holds the securities till maturity and earns interest, where he may reinvest those interest back or distribute it to the investors as per stated investment objective of the fund manager whereas when managers managing portfolio actively he incorporates certain active strategies to earn higher return over his fund.
In active strategies of duration management, the fund manager increases or decreases the duration of his fixed income portfolio based of his view on interest rate. The same strategy is also applied in yield curve positioning where the fund manager takes an active view on only government securities.
Credit spread management is where the fund manager take a view on credit spread between corporate bond and government security to get wider or narrower where as in sector management the fund manager takes active views on economic sectors and bonds issued by companies within the sector or industry.