There are several advantages mutual funds have over stocks. The key advantage funds have over stocks is diversification. Any fund normally invests in a diverse basket of securities, which may include stocks. Consider one of the market favourites, Birla Advantage Fund, a growth scheme with 26.43% of its portfolio in Infosys, 14.75% in VisualSoft and another 8.22% in SSI. With an investment of Rs. 50,000 in the scheme you could own Rs. 13,215 worth of Infosys, Rs.7375 of VisualSoft and Rs. 4110 of SSI. Likewise you would own 27 other stocks that the scheme has put its money in. Is that more satisfying than purchasing seven stocks of Infosys on your own with the same money. Hence, funds make it possible for individual investors to achieve more diversification and with less of their effort than compared to investing in individual stocks. Funds are also professionally managed and backed by an investment research team. The team looks at the performance of companies and then makes investments in them to achieve the objectives of the scheme. Compared to investing in stocks, your experience with fund investing will show you that you save a lot of paperwork as well as time. Under normal functioning, fund investment also does away with common problems associated with stocks like bad deliveries, delayed payments and the frequent visits to brokers and companies.
Historically equity did give better returns than bonds, golds and other assets. But if the long term horizon is assumed to be 7 years, then in the Indian context, the equities have practically given near zero returns.
Besides investing in Government of India securities and money market instruments, they are slightly more overweighed on corporate India. Approximately 50-60% of the portfolio would consist of fixed income instruments issued by corporate India. They therefore provide a higher return typically between 11-12% per annum; ideally suited for investors looking beyond a period of 1 year.
MIP is a variant of income scheme that provides investors an option to get monthly returns in the form of dividends. UTI is the only fund house giving out assured returns on MIP (distributed as post-dated cheques). Private sector mutual funds are not allowed to give assured returns on MIPs. Usually, the returns from such schemes are between 10.5 –11.5%.
Balanced schemes invest both in equity shares and in income-bearing instruments. They aim to reduce the risks of investing in stocks by having a stake in both the equity and the debt markets. These schemes adopt some flexibility in changing the asset composition between equity and debt. The fund managers exploit market conditions to buy the best class of assets at each point in time. By mixing stocks and bonds (and sometimes other types of assets as well, like call money or commercial paper), a balanced scheme is likely to give a return somewhere in between those of stocks and bonds. Bonds add stability during market downturns and volatile periods, while stocks provide growth. Since the return on different types of assets rise and fall at different times, the risk is usually lower in balanced schemes than in pure growth or income schemes.
The part of mutual fund assets that gets removed each year for expenses (which includes management fees, annual operating costs, administrative expenses and all other costs incurred by the fund) expressed, as a percentage is the expense ratio. It provides a quick check of efficiently the fund manager is handling the fund.
Look for one thing in the fine print: the scheme's expenses. One such expense is the bomb of a salary paid to the investment experts who manage the fund. Apart from management fee there is also the money the fund spends on advertising and marketing a scheme. There is a host of operating expenses from buying stationery to maintaining the fund house's staff. Should it matter to you if the fund house purchases a new computer?
It does. In whatever way the fund spends the money, the net expenses are all billed in one way or the other to the unit-holder. The expenses of a scheme do not include brokerage commissions.
They are slightly volatile because 95% of the traded volume of fixed income instruments in India comprise of gilt schemes and therefore pricing of such schemes is done daily.
Getting back to cuisine talk. Do you stop frequenting the Udupi joint round the corner just because a new cook cooked your favourite appam even if it was to your liking? Similarly, there is not much reason to opt out of a fund just because it has a new manager. Managers usually work to the fund house's objective set for a scheme. However, do keep track what the new manager is upto. Is the manager handling the portfolio in a way that it reflects the fund's objectives?
If the new manager churns the portfolio upside down, it might mean more capital gains distributions, and hence more taxes. Obviously then, (and before appams start tasting like idlis) time you looked for another fund.
NAV is the net realizable value of each unit of the scheme. After netting off liabilities from the asset value and dividing by the total number of units outstanding we arrive at the NAV.
No, you may not actually get that much when you redeem your units. That is because of the charges levied by some mutual funds. Though NAV is a good enough figure to tell you what the price of each unit is, it is not an exact one. Funds charge fee for managing your money called the annual expense fee. Some funds also charge a fee when you buy or sell units called the entry and exit load.
In India majority of mutual funds are open-ended. Fund that float open ended schemes can sell as many units as investors demand. These do not have a fixed maturity period. Investors can buy or sell units at NAV-related prices from and to the mutual fund on any business day. Most people prefer open-ended mutual funds because they offer liquidity. Such funds can issue and redeem units any time during the life of a scheme. Hence, unit capital of open ended funds can fluctuate on a daily basis.
These have fixed maturity periods (ranging from 2 to 15 years). You can invest in the scheme at the time of the initial issue. That’s because such schemes can not issue new units except in case of bonus or rights issue.
All is not lost if you missed out on units of a closed scheme. After the initial issue, you can buy or sell units of the scheme on the stock exchanges where they are listed (certain Mutual Funds however, in order to provide investors with an exit route on a periodic basis do repurchase units at NAV related prices). The market price of the units could vary from the NAV of the scheme due to demand and supply factors, investors’ expectations and other market factors.
Much like for an individual investor, a scheme’s objective is the result that a fund manger desires out a scheme. While setting objective for a scheme the manager asks the question: what are the kind of returns I expect the scheme to deliver and to get assure such returns what are the securities and in what proportion should I invest in?
Based on their objectives schemes have been clubbed together in categories. These are broad market classifications and help investors narrow down their search for a scheme. After shortlisting schemes by their common objectives one can further look into each scheme for more specific differences in their objectives.
Equity schemes are those that invest predominantly in equity shares of companies. An equity scheme seeks to provide returns by way of capital appreciation.
As a class of assets, equities are subject to greater fluctuations. Hence, the NAVs of these schemes will also fluctuate frequently. Hence, equity schemes are more volatile, but offer better returns.
The aim of diversified equity funds is to provide the investor with capital appreciation over a medium to long period (generally 2 – 5 years). The fund invests in equity shares of companies from a diverse array of industries and balances (or tries to) the portfolio so as to prevent any adverse impact on returns due to a downturn in one or two sectors.
Gilt schemes invest in government bonds, money market securities or some combination of these.
Gilt schemes tend to give a higher return than a money market scheme at the same time retaining the qualities of a liquid fund. Gilt schemes generally give a return of 8.5-10% per annum whereas it is between 7-8% per annum for money market schemes.
Yes, money market schemes invest in short-term debt instruments such as T-bills, certificates of deposits, commercial papers, call money markets, etc. Their goal is to preserve the principal while yielding a modest return. They are ideal for corporate and big investors looking for avenues to park their short-term surplus funds.
Since they provide the investor to enter or exit within a short period of time without any load. You can even invest for two working days. Normally, you can get back your cash within 24 hours of redemption.
It does in case of schemes that have invested in government instruments like debentures and government securities e.g., debt schemes and some balanced schemes. The volatility of debt schemes depends entirely on the health of the economy e.g., rupee depreciation, fiscal deficit, inflationary pressure.
In debt funds, it is useful to compare the extent to which the growth in NAV comes from interest income and from changes in valuation of illiquid assets like bonds and debentures. This is important because as of today there is no standard method for evaluation of untraded securities. The valuation model used by the fund might have resulted in an appreciation of NAV.
These schemes invest mainly in income-bearing instruments like bonds, debentures, government securities, commercial paper, etc. These instruments are much less volatile than equity schemes. Their volatility depends essentially on the health of the economy e.g., rupee depreciation, fiscal deficit, inflationary pressure. Performance of such schemes also depends on bond ratings. These schemes provide returns generally between 7 to 12% per annum.
Fund managing an index fund is usually called passive management because all a fund manger has to do is to follow the index. Hence, who the portfolio manager or what his style is does not really matter in such funds.
Lack of performance is often explained away as temporary with promises of good performance in the long term. The long term is seldom defined whether it means 3 years or 10 years. Also the longer the period, the longer is the uncertainty, in other words, the premium on returns an investor gets has to be discounted against the risk of uncertainty of returns. A small premium in compounded returns over returns of risk free instruments like PPF wouldn't justify investment in a mutual fund.
Sustained periods of low absolute performance are a cause for concern. It is okay to look at returns vis-à-vis market indices; but if a particular scheme produces absolute returns less than the cumulative returns for a fixed deposit of a bank, then the latter option is better when evaluated on the parameter of risk adjusted returns. This is because generally it is safer to invest in a fixed deposit of a bank than to invest in a debt fund.
This term finds place in the literature of practically all mutual funds. What it basically implies is that a price risk at the entry level can be eliminated to some extent by buying units at various points of time. But this assumes that the NAV will rise eventually. If it does not, you are worse off than by not adopting this strategy.
Taxes don't leave you wherever you make money. But there are smart ways to deal with it. Best be informed. The tax benefits for investing in mutual funds are as follows: Sec 88 of the I.T. Act Twenty percent of the amount invested in specified mutual funds (called equity linked savings schemes or ELSS) is deductible from the tax payable by the investor in a particular year subject to a maximum of Rs2000 per investor. Section 54EA and 54EB of the I.T. Act. Under Section 54EA of the I.T. Act, investment of the entire or part of the net consideration obtained from the transfer of long-term capital assets for a period of three years in mutual fund units, exempts the asset holder from paying capital gains tax. Under Section 54EB of the I.T. Act, investment of the entire or part of the capital gains obtained from the transfer of long-term capital assets for a period of seven years in mutual fund units exempts the asset holder from paying capital gains tax. Sec 115R of the I.T. Act The mutual fund is completely exempt from paying taxes on dividends/interest/capital gains earned by it. While this is a benefit to the fund, it indirectly benefits the unitholders as well. A mutual fund has to pay a withholding tax of 10% on the dividends distributed by it under the revised provisions of the I.T. Act putting them on par with corporates. However, if a mutual fund has invested more than 50% of its assets in equity shares, then it is exempt from paying any tax on the dividend distributed by it, for a period of three years brought about by an overriding provision. This benefit is available under section 115R of the I.T. Act. Section 10(33) of the I.T. Act The investor in a mutual fund is exempt from paying any tax on the dividend received by him from the mutual fund, irrespective of the type of the mutual fund. This benefit is available as the units of mutual funds are treated as capital assets and the investor has to pay capital gains tax on the sale proceeds of mutual fund units sold by him. For investments held for less than one year the tax is equal to 30% of the capital gain. For investments held for more than one year, the tax is equal to 10% of the capital gains. The investor is entitled to indexation benefit while computing capital gains tax. Thus if a typical growth scheme of an income fund shows a rise of 14% in NAV after one year and the investor sells it, he will pay a 10% tax on the selling price less cost price and indexation component. This reduces the incidence of tax considerably. This concession is available under section 48 of the I.T. Act. The following calculations show this in more detail: Purchase NAV = Rs 10 Sale NAV = Rs 11.4 Indexation component = 7% Capital gains = 11.4 - 10(1.07) = 11.4 - 10.7 = 0.7 Capital gains tax = 0.7*0.1 = 0.07. If an investor buys a fresh unit in the closing days of March and sells it in the first week of April of the following year, he is entitled to indexation benefit for two financial years which close in the two March ending periods. This is termed as double indexation and lowers the tax even further especially for income funds. In the above example, the calculation would be as follows: Capital gains = 11.4 - 10(1.07)(1.07) = 11.4 - 11.45 = -0.05 Eventually in this case, there would be no capital gains tax. The investor in a mutual fund is exempt from paying any tax on the dividend received by him from the mutual fund, irrespective of the type of the mutual fund. This benefit is available as the units of mutual funds are treated as capital assets and the investor has to pay capital gains tax on the sale proceeds of mutual fund units sold by him. For investments held for less than one year the tax is equal to 30% of the capital gain. For investments held for more than one year, the tax is equal to 10% of the capital gains. The investor is entitled to indexation benefit while computing capital gains tax. Thus if a typical growth scheme of an income fund shows a rise of 14% in NAV after one year and the investor sells it, he will pay a 10% tax on the selling price less cost price and indexation component. This reduces the incidence of tax considerably. This concession is available under section 48 of the I.T. Act. The following calculations show this in more detail: Purchase NAV = Rs 10 Sale NAV = Rs 11.4 Indexation component = 7% Capital gains = 11.4 - 10(1.07) = 11.4 - 10.7 = 0.7 Capital gains tax = 0.7*0.1 = 0.07. If an investor buys a fresh unit in the closing days of March and sells it in the first week of April of the following year, he is entitled to indexation benefit for two financial years which close in the two March ending periods. This is termed as double indexation and lowers the tax even further especially for income funds. In the above example, the calculation would be as follows: Capital gains = 11.4 - 10(1.07)(1.07) = 11.4 - 11.45 = -0.05 Eventually in this case, there would be no capital gains tax.
Once again, back to the basic question. You came here looking for schemes that can suffice your investment needs. You might be like many others who actually have multiple needs. Consider going for a combination of schemes. Yet another recap of the basics: one of the things that made these mutual funds great was diversification. While you might have selected a scheme that has a diversified portfolio, you can also go for more than one schemes to further diversify your investments. It is well possible that just by picking more than one scheme from one fund house you can achieve enough diversification. In fact many investors who have tried out a fund house for long and developed a trust with the fund, prefer to pick another scheme from the fund's basket for their new investment needs. But convenience sometimes leads to venerable prejudices that might deprive you of trying something new and better. There could be a better-managed scheme in a different fund house house that you are missing out on if you decide to stick to your old fund house for convenience sake.
Higher the turnover more the trades a fund does and hence greater are the transaction fees in the form of brokerage, custody fees, registration fees etc. that a fund has to pay. For a fund such high transaction costs affects its performance and the NAV. And as an investor you get less returns. Moreover, a fund with high turnover will also be making money more often as capital gains. These capital gains on distribution are open to taxes, which again would mean less returns for a untiholder.
Good portfolio handling depends a lot on precise timing and correct estimations. By how much and when does a fund manager change his investment mix? The portfolio of a fund never remains the same for a long time. Is the fund manager's investment strategy one of buy and hold? Or is he a one who aggressively churns the fund? But most importantly, is he taking the right decision at the right time? Though as investors we don't always get to know when a manager is changing the scheme's portfolio, we can periodically keep track of the scheme's trading history.
Most schemes periodically announce their current portfolio though not all of them declare them as when the fund manager makes a change. As specified by the Securities and Exchange Board of India (SEBI) funds are supposed to declare their portfolio at least once every year.
The volatility of index funds are in sync with the index they follow. A bull market could get you as high as 40% returns over a period of one year. In a bad year (current year) it could erode your principal by as much as 30%.
Contrary to the commonplace thinking, mutual funds do carry risks. And there are some that can become as risky as stocks. Given the almost diverse objectives with which schemes operate, there are some with more risks and some relatively safer. Ask yourself if you are ready for a scheme whose investment value might fluctuate every week or one that gives a minimum amount of risk?
Or are you in for a short-term loss in order to achieve a long-term potential gain?
At this point it is good to ask oneself how will you take it if your investment fails to deliver the returns you expected or makes losses. Knowing this will reduce your chances (or even temptation) to select a fund that doesn’t come close to your objective. Evaluate a scheme by looking at how its NAV has behaved over the past. Do you see the scheme behaving rather erratically i.e., the NAV changes just too often?
More the volatility more are the risks involved. Great returns are not the only thing to look for in a scheme. If you feel while researching a scheme, which we will do later, that it’s returns are modest and steady and good enough for your needs, avoid other schemes that have recently delivered high returns. Because great returns in the past are no guarantee for the fabulous performance to continue in the future. Never forget one of the commonplace morals of investment: The schemes that are expected to give the highest returns have the greatest probability to fall flat!
It is surprising to find fund marketers come up with statistics to show how their particular fund has done extremely well. Following are some of the pitfalls that an investor needs to look into before arriving at a decision. Check the following details before arriving at any decision. Period of declared returns: Always look carefully at start and end dates - they can always be chosen in a way that shows the fund in a favorable light. A better approach would be to choose a reasonably longer period and compare the performance across the similar schemes of different players. Concept of out-performing: Sustained periods of low absolute performance are a cause for concern. It is okay to look at returns vis-à-vis market indices; but if a particular scheme produces absolute returns less than the cumulative returns for a fixed deposit of a bank, then the latter option is better when evaluated on the parameter of risk adjusted returns. This is because generally it is safer to invest in a fixed deposit of a bank than to invest in a debt fund. Promise of long term performance: Lack of performance is often explained away as temporary with promises of good performance in the long term. The long term is seldom defined whether it means 3yrs or 10 yrs. Also the longer the period, the longer is the uncertainty- in other words, the premium on returns an investor gets has to discounted against the risk of uncertainty of returns. A small premium in compounded returns over returns of risk free instruments like PPF wouldn't justify investment in a mutual fund. Rupee cost averaging: This term finds place in the literature of practically all mutual funds. What it basically implies is that a price risk at the entry level can be eliminated to some extent by buying units at various points of time. But this assumes that the NAV will rise eventually. If it does not, you are worse off than by not adopting this strategy. In the long run equities are better than other asset classes: Historically the equity class did give better returns than bonds, golds and other assets. But if the long term horizon is assumed to be 7 yrs, then in the Indian context, the equities have practically given near zero returns.
All funds are supposed to put up for public a rather technically worded document called the prospectus. This long not-too-exciting tome usually starts off with a statement declaring the purpose a fund follows for a particular scheme. Reading along, somewhere the prospectus will also tell you how to apply for the scheme and how to redeem units. Being a tome, it has voluminous information that can also confound you. The smart way then is to run through the prospectus and extract for yourself convincing answers to these six vital questions that all investors need to know before they buy a fund.
All mutual funds schemes have different objectives and therefore their performance would vary. But are there some standards for comparison?
Schemes are usually benchmarked against commonly followed market indexes. The relevant index can be chosen after taking into consideration the asset class of the scheme. For example BSE Sensex can be used a benchmark for an equity scheme and I-Bex for an income fund. But if you switch the benchmarks, conclusions could be misleading. Benchmarking also requires a relevant time period of comparison. Ideally, one should compare the performance of equity or an index fund over a 1-2 year horizon. Short-term volatile price movements would distort any comparison over a shorter period. Similarly, the ideal comparison period for a debt fund would be 6-12 months while that for a liquid/money market fund would be 1-3 months. So if a comparison reveals a scheme to be out performing its index, does it mean it is going to deliver super returns?
Not necessarily. In several cases it is noticed that the funds performance is volatile and driven by few scrips. In other words, the fund manager has taken significantly higher risks to achieve higher returns. That brings us back to the oft-repeated moral in the investment market: The funds that have the potential for the greatest returns also have the greatest potential for losses. From an investor's point of view, while looking at impressive returns in the past, he cannot derive confidence and comfort in the fund managers' ability to repeat the performance in future.
What are you looking for when investing in mutual funds?
What are your investment needs?
The more well defined these answers are the easier it is to find schemes best for you. So how do you assess your needs?
The answers obviously lie with you. But the questions investors ask to assess their needs are possibly the same. You might ask yourself: At my age what am I expecting out of investing?
To assess the needs investors look at their lifestyles, financial independence, family commitments, and level of income and expenses among other things. Questions can be many but to get cracking ask yourself these two: What are the returns you want on your investments?
Do you have well-defined time period for the returns you expect on your investment?
The father of an aspiring engineer who would have to shell out the boy's institute fees soon enough, could reply: I want a fixed monthly income of about Rs.5000 per month. To the second query he might say: Yes, for the next four years. When asked, the just-out-of-B-school graduate planning for his new Zen could reply: I should make about Rs. 60,000 by the end of one year. Believe us, but getting the right answers to these questions does a lot to simply your fund picking exercise. Having defined the needs that direct you to invest, one can find a category of funds that come close to satisfy your needs with their objectives.
It's a trick company ads often do. A tempting offer is always accompanied with the fine print tucked in a corner at the bottom of the ad. And sometimes reading the applied conditions in the fine print might squeeze all the attractiveness out of a great sounding offer. Buying a scheme also requires that you give a careful look at the fine print. Should it matter to you if the fund house purchases a new computer?
It does. In whatever way the fund spends the money, the net expenses are all billed in one way or the other to the unitholder.
We have broadly grouped schemes by the following categories: Equity schemes These are further divided into Diversified Equity schemes, Sectoral Equity schemes, Equity Linked Saving Schemes (ELSS) and Index schemes. Debt schemes These are further clubbed into Liquid or Money Market schemes, Gilt schemes, Income schemes and Monthly Income Plan schemes. Balanced schemes.
While looking for schemes we want ones that best fit our investment objective. So, now which are those schemes that suit our objectives best?
The obvious next step then is to look all fund schemes and make a match between their and our investment objectives, correct?
Hmmm, that’s not as simply done as it sounds. Unless you have all the time in the world, going through each of the 350 or so schemes in the market today and reading their investment objectives is a foolhardy job. What makes life easier is that based on their objectives schemes have been clubbed together in categories. These are broad market classifications and help investors narrow down their search for a scheme. After shortlisting schemes by their common objectives one can further look into each scheme for more specific differences in their objectives.
Let us get back to the basic questions that brought us here. We are here to invest with some objective of our own. And we are looking for schemes that best fit our investment objective. So, now which are those schemes that suit our objectives best?
The obvious next step then is to look all fund schemes and make a match between their and our investment objectives, correct?
Hmmm, that’s not as simply done as it sounds. Unless you have all the time in the world, going through each of the 350 or so schemes in the market today and reading their investment objectives is a foolhardy job. What makes life easier is that based on their objectives schemes have been clubbed together in categories. These are broad market classifications and help investors narrow down their search for a scheme. After shortlisting schemes by their common objectives one can further look into each scheme for more specific differences in their objectives.
Funds can change the load structure periodically. If you are a unitholder of a scheme that charges an exit load, and the scheme changes its exit load structure, then you will get a prior notice of the change. The new structure will be applicable to you rather than the load structure you were informed about when you joined the scheme.
Contingent Deferred Sales Load (CDSL) is a charge imposed when the units of a fund are redeemed during the first few years of ownership. Under the SEBI Regulations, a fund can charge CDSL to unitholders exiting from the scheme within the first four years of entry.
Just like entry load some funds impose a fee when you leave the scheme, i.e., redeem your units, called the exit load.
No fund can do away with its expenses. And all funds pass on the expenses to the unitholders.
The costs of the fund management process that includes marketing and initial costs are charged when you enter the scheme. These charges are termed the entry load, the additional charge you pay when you join a scheme and something everyone will tell you to watch out for. And if there is nothing to watch out for, i.e., the bold font in the new scheme's ad says `No entry load'. Will you jump for it?
Come on, investment was all about smartness. No fund can do away with these charges. What funds that come with such offers usually do is to include these charges not in the entry load but somewhere else. It could also be deducted from the returns that you get.
Great returns are not the only thing to look for in a scheme. If you feel while researching a scheme, which we will do later, that it’s returns are modest and steady and good enough for your needs, avoid other schemes that have recently delivered high returns. Because great returns in the past are no guarantee for the fabulous performance to continue in the future. Never forget one of the commonplace morals of investment: The schemes that are expected to give the highest returns have the greatest probability to fall flat!
Globally it is true that most fund managers underperform the asset class that they are investing in. This is largely the result of limitations inherent in the concept of mutual funds: Fund management costs: The costs of the fund management process that includes marketing and initial costs are charged at the time of entry itself in the form of load. Then there are the annual asset management fee and operating expenses. The performance of a scheme net of these expenses lead to a relatively lower performance vis-à-vis the index stocks. Churning cost: The portfolio of a fund is never static. The extent to which the portfolio changes is a function of the style of the individual fund manager i.e. whether he is a buy and hold type of manager or one who aggressively churns the fund. Such portfolio changes have associated costs of brokerage, custody fees, registration fees etc. which lowers the portfolio return commensurately. Large size: When a large body like a mutual fund transacts in securities, the concentrated buying or selling results in adverse price movements. This causes the fund to transact at relatively higher entry or lower exit prices. Time lag for investment: Most mutual funds receive money when markets are in a bull run and investors are willing to try out mutual funds. Since it is difficult to invest all funds in one day, there is some money waiting to be invested. Further, there may be a time lag before investment opportunities are identified. This causes the fund to realize lesser returns vis-à-vis the index stocks. Also for open-ended funds, there is the added problem of perpetually keeping some money in liquid assets to meet redemptions. Change in composition of index stocks: The composition of the indices has to change to reflect changing market conditions. The BSE Sensex stock composition has been revamped twice in the last 5 years, with each change being quite substantial. Another reason for change of index composition could be Mergers & Acquisitions. Herd mentality: Apparently, the only way a fund can beat the index is through investment of some part of its portfolio in some shares where it gets excellent returns, much more than the index. This will pull up the overall average return for the scheme. In order to obtain such exceptional returns, the fund manager might have to take a strong view and invest in some uncommon stocks. Unfortunately, if the fund manager does the same thing as several others, chances are that he will produce average results. The tendency of the fund managers to buy the popular stocks, which are favourites among their peers, leads only to average performance as the index.
It is well possible that just by picking more than one scheme from one fund house you can achieve enough diversification. In fact many investors who have tried out a fund house for long and developed a trust with the fund, prefer to pick another scheme from the fund's basket for their new investment needs. But convenience sometimes leads to venerable prejudices that might deprive you of trying something new and better. There could be a better-managed scheme in a different fund house that you are missing out on if you decide to stick to your old fund house for convenience sake.
Money is dear money. You wouldn't put your dear money into any investment without fully convincing yourself. With a comparison with other schemes you can convince yourself whether the scheme you have chosen is best for you. Of course, while shortlisting schemes through the advanced search you have already performed a comparison for some of the criteria on which mutual funds are judged. Time you enriched the comparison. For example, in debt funds, it is useful to compare the extent to which the growth in NAV comes from interest income and from changes in valuation of illiquid assets like bonds and debentures. This is important because as of today there is no standard method for evaluation of untraded securities. The valuation model used by the fund might have resulted in an appreciation of NAV. The expenses ratio can be compared across similar schemes to find out whether the fund is prudently managing its expenses. The size of the fund plays an important role here and a smaller fund generally has higher expenses per net assets managed. The NAV, returns and performance are important criteria that establish the merit of a fund but the only differentiating factors. It is prudent to also compare the risk-adjusted returns and the corpus size of the fund. The risk-adjusted return will help in evaluating what returns one can theoretically expect in the worst of condition. The risk is measured through volatility of the returns which is nothing but the standard deviation from the average returns. What are those factors that make schemes risky?
And to what proportion is each scheme exposed to each of these factors?
Identifying these factors or in other words, establishing the risk profile and then comparing it across schemes helps in creating, though theoretically, a relative scale of safety among the schemes compared. For debt funds, one of the factors could be the periodic changes in the interest rate environment, which affects credit quality of the portfolio and brings about fluctuations in the NAV. For equity funds, it could mean the volatility of the NAV with the ups and downs in the market or the percentage exposure to smaller companies.
Having shortlisted schemes the next step is to look at each of them in greater detail and also make a qualitative evaluation. One place to look at is the offer document of the scheme. The offer document of the scheme tells you its objectives and provides supplementary details like the track record of other schemes managed by the same fund manager. Some other factors could be the portfolio allocation, the dividend yield and the degree of transparency as reflected in the frequency and quality of their communications. Does the scheme provide prompt and personalised service or does the scheme maintain transparency?
All this can be looked at from the frequency and quality of the communication from the fund house.
One good reason for looking at the past performance (prospectus presents this in a chart) is to find out how consistently has a fund delivered good returns, or even poor returns.
One way of looking at the past performance (the fund prospectus presents this in a chart) is to find out how consistently the fund has delivered good returns, or even poor returns.
Look out for that important number mentioned somewhere in one of the tables called the expense ratio.
Prospectus are supposed to elucidate the risks in their investments but convince yourself what risks are inherent in the investment style the fund promises to follow.
Compared to the objective a strategy is a more concrete statement of the money making purpose of the fund. While a fund will tell you very clearly what the fund intends to invest in, check what it says about where it will not invest in.
Note that most investment objective are vague and visionary statements. So it's good to also check how is the strategy of the fund defined.
Not necessarily. In several cases it is noticed that the funds performance is volatile and driven by few scrips. In other words, the fund manager has taken significantly higher risks to achieve higher returns. That brings us back to the oft-repeated moral in the investment market: The funds that have the potential for the greatest returns also have the greatest potential for losses. From an investor's point of view, while looking at impressive returns in the past, he cannot derive confidence and comfort in the fund managers' ability to repeat the performance in future.
Asset size also matter in case of small funds when they suddenly become big. For example, the excellent handling by the fund manager of a small fund may suddenly become popular and draw a lot new unitholders. The sudden flush of funds could lead to a change in the manager’s investment style that might record a drop in performance.
Investing and managing the collected money is a difficult task. The fund company delegates this to a company of professional investors, usually experts who are known for smart stock picks. This company is the Asset Management Company (AMC) and the fund company usually delegates the job of investment management for a fee.
Popularity has a flip-side which works against the funds many times. Consider this: If under some circumstances, a large number of untiholders decide to sell i.e. redeem, their units all at the same time, the fund will have to, at a short notice, generate enough cash to pay up the unitholders. The fund manager then faces what is called redemption pressure. He would have to sell off a significant portion of the scheme’s investments. If the markets are down the sell off could be at a throwaway price. Naturally then, more the investors in a scheme more the chance of a sudden redemption pressure.
A mutual fund is a trust that pools the money of several investors and manages investments on their behalf. Legally it is like any other company you know of. Hence, the fund is also called a mutual fund company. The fund company takes your money and like you from other new investors. This is added to the money that's already invested with the fund.
Some investors see asset size as an indicator of popularity. A scheme with large assets could be subscribed to by large number of unitholders.
Asset, of course, is the investments of a mutual fund. And value is the market value of investments. What exactly is market value?
Let’s say a fund has invested its money in stocks. Then, the price of those stocks on the stock market multiplied by the number of stocks owned gives you the value of all the investments made by that mutual fund. This value can change either when the market valuation changes or if people are joining or leaving the scheme.
When you buy into a scheme of a mutual fund you are holding units of the scheme. Buying units is like owning shares of a scheme.
A fund collects money from investors through various schemes. Each scheme is differentiated by its objective of investment or in other words, a broadly defined purpose of how the collected money is going to be invested. Based on these broad purposes schemes are classified into a dozen or so categories about which more later.
The costs of the fund management process that includes marketing and initial costs are charged when you enter the scheme. These charges are termed the entry load, the additional charge you pay when you join a scheme.
Investors comfortable with numerical recipes do a technical check of what the returns of a scheme would be in the worst case. They check is done with the Sharpe ratio. The higher the Sharpe ratio, the better the fund's historical risk-adjusted performance.
While we are on the topic of what returns to expect, someone might as well wish for a fund that assures returns. Some of the mutual funds have floated "assured" return schemes that guarantee a certain annual return or guarantee a buyback at a specified price after a specified period. Examples of these include funds floated by the UTI, SBI Mutual Fund, etc. Many of these funds have not earned returns that they promised and the asset management companies of the respective mutual funds or their sponsors have made good their promises. Nowadays, there are very few funds that come out with such schemes as the funds have realized it is not viable to assure returns in a volatile market.
Schemes with smaller assets to manage and particularly those that are not part of a large fund house will generally have higher expenses relative to schemes with larger assets. Fresh schemes generally take some time to overcome their expense burden.
Badly managed funds that have schemes with consistently higher expenses compared to funds of the same category with lower expenses, find it tough to curb their expenses.
By examining past performance you can get an almost certain idea of what the expenses for a scheme could be in the future. That's because the expenses don't depend on a scheme performance. It's dependent on the deftness of the fund manager.
Any day, lower the expenses the better it is. Smart and well-managed funds keep their expenses low. Smarter funds know exactly how to make their offerings attractive by smartly tucking away expenses either in entry load or exit load or by cutting on returns. And smart investors always get to beat the funds by figuring out where all the expenses are included. Right?
Needless to say, loads if any are only applicable to open schemes. And not close-ended schemes because for such schemes units can be bought from the fund only at the time of launch.
Now don't get too hassled about loads. Best thing to do when a scheme imposes a new load, is not to invest more money if the load charged is unreasonable.
If you are a unitholder of a scheme that charges an exit load, and the scheme changes its exit load structure, then you will get a prior notice of the change. The new structure will be applicable to you rather than the load structure you were informed about when you joined the scheme.
If you already hold a scheme NAV tells you on any day, the realizable value of each unit of the scheme. What that means is that it is the money you will get for each unit of the scheme, if the scheme is liquidated on that date or you want to exit the scheme. If you are planning to buy a scheme In other words, NAV is the value per share. It lets you know how much your investment is worth at a particular time. It is the most important measure of the performance of a mutual fund. Let’s say you have invested in a scheme at Rs 10 a unit and now its NAV is Rs 12. Quite simply, that means your investment has appreciated by 20%.
Buying a scheme is like buying potatoes with a limited budget. With Rs.400 you can either buy 10 kg of the Rs.40 per kg-variety or 20 kg of the Rs.20 per kg-variety. NAV tells you how much it will cost you to buy one unit of a scheme on any given day. So if you have Rs.50,000 in your pocket you can buy 1000 units of a scheme that is offering units at an NAV of 50 or you might buy 500 units of a pricier scheme with an NAV of Rs.100. Hold it. You may have to pay more than what the scheme’s NAV tells you. That is because of the charges levied by some mutual funds. Though NAV is a good enough figure to tell you what the price of each unit is, it is not an exact one. Funds charge fee for managing your money called the annual expense fee. Some funds also charge a fee when you buy or sell units called the entry and exit load.
The frequency with which a portfolio is churned is indicated by the turnover ratio, which is expressed as a percentage. A fund with a 100% turnover generally changes the composition of its entire portfolio each year. Low turnover of about 20-30% shows a fund following a cautious strategy i.e., buying stocks and holding them. Turnover in excess of 100% shows a fund into active trading i.e., one that sells and buys stocks very often. Hold it. Technically speaking, a turnover ratio is a ratio comparing the rupee value of fund purchases or sales to the rupee value of total fund assets during the year. Hence, a 100% turnover ratio could also indicate that only a portion of the entire portfolio has been traded intensely over the last year.
It’s all about the recipe. Just like successful cooking, a fund’s ability to fulfil the moneymaking objective of a scheme is determined by its recipe. The recipe for a scheme is its portfolio, which is mix of the investments the fund intends to make for the scheme. The fund invests its assets by buying a mix of various securities like stocks or bonds. Depending on the scheme’s objective, the fund manager fixes the investment recipe or the portfolio. The portfolio, on any day, consists of the various securities the fund has invested in. By purchasing into a scheme you become a part owner of that portfolio.
It is not necessary that schemes with huge assets, say above Rs.200 crores, may give better returns than smaller schemes, say of assets levels below Rs.75 crores. A scheme, due to a huge corpus, has more options than a smaller scheme to make diversified investments. However, smaller schemes due to their small corpus of funds are more nimble in shifting money from one investment to another and making focussed investments. For funds that actively manage stocks a huge corpus might matter sometimes because of the frequent illiquid state of the Indian stock markets. The bigger in size these funds become the more difficult it becomes to trade stocks. The fund may lose some flexibility when assets reach a certain size because of trading and stock selection difficulties. Size can also be a detriment to funds specializing in small stocks. These stocks have less trading volume, and it can be difficult to trade larger positions without affecting prices.
Always look carefully at start and end dates - they can always be chosen in a way that shows the fund in a favorable light. A better approach would be to choose a reasonably longer period and compare the performance across the similar schemes of different players.
Index funds are schemes that try to invest in those equity shares which make up a particular index. For example, an Index fund which is trying to mirror the BSE-30 (Sensex) will invest in only those 30 scrips that constitute this particular index. Investment in these scrips is also made in proportion to each stocks weight in the index.
Equity Linked Saving Schemes (ELSS) offer tax rebates to the investor under section 88 of the Income Tax law. These schemes generally diversify the equity risk by investing in a wider array of stocks across sectors. ELSS is usually considered a variant of diversified equity scheme but with a tax friendly offer. Typically returns for such schemes have been found to be between 15-20%.
No. That’s because diversified schemes invest in equity shares of companies from a diverse array of industries and balances and prevent any adverse impact on returns due to a downturn in one or two sectors. Sectoral funds tend to have a very high risk-reward ratio and investors should be careful of putting all their eggs in one basket. Investors generally see such schemes to benefit them in the short term, usually one year.
Those investors looking for benefits in the short term, usually one year. That’s because such schemes tend to have a very high risk-reward ratio and investors should be careful of putting all their eggs in one basket. Returns could be as high as 50% in a good year provided the investor chooses the right sector.
These are schemes whose objective is to invest only in the equity of those companies existing in a specific sector, as laid down in the fund’s offer document. For example, an FMCG sectoral fund shall invest in companies like HLL, Cadbury’s, Nestle etc., and not in a software company like Infosys. Currently there exist approximately four broad classification of basic sectors namely – technology, media & telecom (TMT), fast moving consumer goods (FMCG), basic industry (that invest in core industries like petrochemicals, cement, steel, etc.) and pharmaceuticals.
A market index is very important because one, it acts as a barometer for market behaviour, and two, it helps in benchmarking portfolio performance. For a particular category of mutual funds called the index funds, these indexes are used for passive fund management i.e. all a fund manager has to do to manage his portfolio is blindly follow the composition of the index. The role of a good index is to reflect the state of the overall market at every moment and indicate how the stock market perceives the Indian corporate sector to fare.
A mutual fund may not be able to meet the investment objectives of all unit holders through just one portfolio. Some unit holders may want to invest in risk-bearing securities such as equity, while others may want to invest in safer securities like bonds or government securities. Moreover, there are so many varying risks associated with different securities that it is often impossible for one individual to manage them. Therefore, a mutual fund tries to create different classes of risk portfolios by formulating different investment schemes. Each investment scheme specifies the kind of investments the scheme will make out of the monies collected.
The drawbacks with mutual funds are that you have no control on the investments of the fund; and, more importantly, the downside of diversification is that a fund can hold so many stocks that a tremendously great performance by a stock will make very little difference to a fund's overall performance.
Mutual funds have many benefits. They offer an easy and inexpensive way for an individual to get returns from stocks and bonds without: incurring the risks involved in buying them directly; needing the capital to buy quality stocks; or having the expert knowledge to make the right buy/sell decisions.