Variety is the spice of life - an adage that can apply well to the world of mutual funds. While there are funds that suit every need, the presence of multiple schemes with similar attributes within the same mutual fund or spread across the industry is actually a source of trouble for investors. The securities regulator, mercifully, is aware of the situation and has recently made the right noises with a view to reduce the number of schemes, loosely called "me-too" funds, that carry similar basic attributes.

Me-too funds, now being seen as a niggling issue, is a result of the asset management industry's constant urge to build its asset base. Such funds, both equity and debt, exist in fair numbers. A large and influential section of fund houses can be held responsible for this state of affairs.

A quick glance at the charts will indicate the extent and nature of the issue. On the equity side, for instance, there is an overwhelming presence of funds that dabble in mid-cap stocks. Therefore, when it comes to distribution of such funds, there is considerable activity on the part of the asset management firms. True distinction and differentiation, however, is lacking.

Merger, the answer

The market watchdog has spoken in favour of consolidating some of the funds in order to empower the investor fraternity. This, it is felt, will help investors in a lot of ways. First, the incidence of holding of similar portfolio - a rather unnecessary strategy for the average investor to pursue - will be reduced. Two, it will be easier for participants to exercise choice. At the end, consolidation will help investors to select the right kind of products.

The point to note, nevertheless, relates to determining the real basis of such mergers. How will "similar attributes" be precisely defined? Should we go by mere investment objectives alone? Or should we narrow down the logic further and ascertain whether constituents of two portfolios have actually overlapped beyond a pre-determined limit?

Take, for instance, two comparable equity funds (A and B, for our purposes) offered by an asset management company. Fund A and Fund B, let us assume, both strive to create wealth for their unit holders by aiming at capital appreciation. Both, let us also suppose, have diversified portfolios and are benchmarked against the same index.

However, the AMC in question had made sparse, cursory attempts at product differentiation when these were launched. At any rate, the two were rolled out on different dates, at two different phases of the market. Their historical returns also vary. The AMC has simply provided different and distinctive names to the two funds. When it comes to selling the funds on an on-going basis, they are pitched differently too.

Scenarios like this exist in the real world in sufficient numbers. This, as you will no doubt agree, can potentially confuse investors who are looking for suitable equity funds that would satisfy their wealth-building needs. Or, for debt funds that would meet their objective of securing steady income flows.

A consolidation, therefore, must be seen as a well-meaning exercise, to be carried out in a manner that would protect unit holders' interests. As things stand, trustees must approve such a proposal. Also, an exit window must be provided to the investors concerned as part of the merger procedure.

A number of mergers have taken place over the last few years, including ones that have been typically conducted to unite a weak fund (with a small asset size, I should point out) with another that is performing well. Yet, despite the trend and notwithstanding the regulatory clarity that exists on the issue of consolidation, fund houses have not been too forthcoming on this front.

Yes, there seems to be a definite reluctance on their part in effecting mergers. The strain on AMCs to preserve their assets and the incessant challenge to hold on to their investors may be among the reasons why mergers have not been pursued by the asset management industry.

Strong vs weak

Compared to the weaklings, the better performing funds are always likely to draw the attention of investors and their financial advisers. Most fund houses tend to propagate the ones that have been delivering superior returns (compared to peers within the same group). Distributors of mutual funds too highlight these products, often urging clients to choose them strictly on the basis of historical performance.

A close look at various portfolios of similarly-attributed funds would probably reveal significant overlap. Now, this is not a happy scenario in so far as investors are concerned. I am particularly referring to their need to attain true diversification - a need which they fail to satisfy in this case. Indeed, they do not deserve to bear the burden of underperforming, me-too funds.

The collected wisdom is that mergers (of weak funds with strong ones) should be conducted in a seamless manner with minimum fuss. In other words, the paperwork for investors should be limited. Regulatory compliance must be achieved quickly and at no or minimum cost. In an era when online transactions are gaining ground, such compliance should not pose a major problem.

To conclude

Consolidation, I must mention here, is a goal that the regulator should pursue for the benefit of ordinary investors who go by sheer returns. Two objectives can be achieved.

Sharper portfolios: A fund manager will have fewer funds to handle once his AMC achieves the desired level of consolidation. His focus will be clearly on products that are already doing well but have absorbed one or more weak funds with similar attributes.

Lower costs: In an ideal scenario, it is cheaper for fund houses to manage fewer products. Cost structure is a tricky subject for savings and investment products; issues related to transaction costs are already a big bother for investors worldwide. India is no exception. Any exercise that lowers costs should be welcome by all concerned.

The author is director of Wishlist Capital Advisors