Underpriced mutual funds: Market inefficiency or something else?

When Prime Finance 1st Mutual Fund debuted on the market in 2009, its units were trading at five to seven times above the face value. If that is an unusual phenomenon, stranger was the fact that the fund had not even completed its portfolio before witnessing such wild price hikes.

However, the hype did not sustain for long.

But such strange mispricing of mutual funds is fairly commonplace.  

After the 2010 market crash - which analysts consider a consequence of extreme overpricing due to the lack of a culture to look into actual values of stocks - the market irrationalities had been well addressed by experts.

Secondary market prices were coming closer to the intrinsic value of the securities.

It was then that many individuals and institutions started subscribing to mutual funds to let the professionals do the job better.

But over the last four to five years, pricing irrationality has again come back. This time the mutual funds are priced much below their asset values.

Now investors at the secondary market are not willing to pay even Tk4 to 5 for many of the Tk10 assets.

The Tk10 note analogy

A market analyst likened the mispricing behavior to a Tk10 bill. 

"Suppose, somebody on the street is offering Tk10 bills for Tk5-6. What shall we do?" he said. 

What we will do is take an instant look at whether the notes are fake or genuine.

"If not fake, we will rush to take the offer. If not me, someone else will. If not us, professional currency traders or money market players will come to take the opportunity. If in our city there is no such professional player, the vacuum will be filled through the creation of new local entities or arrival of someone from abroad." 

Because everybody is confident that each of the notes will buy products or services worth Tk10.

The simplest version of mutual fund analysis guideline suggests mutual fund units are almost similar to the Tk10 notes in terms of finding the actual present value, based on which we can decide what we should pay for a mutual fund's each units.

A mutual fund is a collective investment scheme, which is nothing but a large basket of assets. According to mutual fund rules the asset basket includes both listed and non-listed equity and debt securities, cash and fixed deposits. 

The assets have a current price in market. Each mutual fund has to calculate and publish the present value of all its assets, expressed as NAV (net asset value) on a weekly basis.

A mutual fund's current asset value is an indication how its units should be priced. Investors may be willing to pay moderately more or less over their values. It depends on the asset basket's quality, risk and return potential, expectation for dividends and capital gains, and very importantly, the freedom to withdraw investments on time.

But in Bangladesh, the deviation from the ideal reference for price has been too wide and it has kept many experts wondering for long.

Argument for improved efficiency

In finance, an efficient market tends to best reflect the actual value of securities through pricing and vice versa.

Experts say the capital market of Bangladesh still belongs to the group of the world's inefficient markets.

Some of them think listed mutual funds can be regarded as the crudest example of that. Inefficient markets tend to widely misprice assets, and listed mutual funds here are exactly doing the same.

Some other analysts, while talking to The Business Standard, argued that the market as a whole is not as irrational as before. Because all the mutual funds are not widely mispriced.

Listed mutual fund units representing over half of the assets under management at the local closed-end fund management industry are trading at 60 percent discount.

But rest of the funds are trading at much less discounts. A very few are even trading above the funds present asset value, which is called a premium.

It is rather investors' confidence which is driving their willingness to pay for listed funds' units. And the confidence is being hurt at regular intervals due to emergence of series of hurdles.

"It is a consensus among the analyst community that the market is punishing the funds through discounts proportionate to the lack of trust and confidence on the specific asset manager and the regulatory system," said one of the analysts who believes the market is more mature now.