Myths about Investing in Mutual Funds

This article deals with the myths about investing in mutual funds.
Myth No:1. It is better to invest in a scheme with Rs.10.00 as NAV (Face Value) than investing in an existing scheme with NAV Rs 14.00

let us consider that the the NAV appreciates from Rs. 10 to Rs.11 and the NAV of Rs. 14 to Rs. 15.40; Now the appreciation in both schemes are identical - both has given 10% increase only. Identiacl schemes in the same period gives identical returns. So the crux of the matter is not the NAV per se but whether the schemes are identical in all aspects!! The NAV shows the realized performance. So please do not penalise good performance by fund managers.

Myth No:2. Long term investments give good returns. So one needs to buy & hold only.

Even if the investments are made on a long term basis, one needs to periodically, at least once in an year, review the performance of the fund & one's dsireability in holding it further in view of changes in macro-economic factors as also personal life goal shifts. Again, it is the aggressive growth stage of mutual funds as far as India is concerned. So it is possible to have mergers & acquisitions happening in a big way. It could be scheme mergers of the same fund family, or between funds. There is also need for updating the change of address/bank account as th einvestor changes residence/bank etc.. Some times, the fundamental attributes of the scheme is altered by the fund providing information to the investor. So it is in the interest of the investor to annually once see what is happening on his investments, whether he should continue holding or change course.
Myth No:3. (Systematic Investment Plan)SIP is a panacea for anythng & everything.

Some people belive that SIP is a cure for all investment needs. SIP is only a beginning. As you earn, you save. But, to translate it into life goals is really amatter of concern. The cash flows at the time of requirement should be sufficient to meet the life goals. The decisons about SIP is concerned with
How much amount?
What periodicity?
Which fund?
Which scheme?
What period?
What frequency?
This is where more thoughts needs to go.

Myth No: 4. Index funds do not give good returns. Fund Managers do not manage it.

Index funds give returns equivalent to that of the Index being tracked. If BSE sensex is tracked by the fund as taht in Master Index fund of UTI MF, both should give same returns in the same period. It is achieved by the fund manager by mimicing a portfolio as taht of the index. Ofcourse, the fund manager's skills are to the extent of manging the dividends/bounses received, always maintaining the portfolio composition as that of the index. Therefore operating expenses are kept low. Not much is spent for portfolio selection as well. In totality, one can say that, these low cost funds are best suited for common man looking at taking same risk as that of the market.

Myth No: 5. Dividend Scheme is better than the growth scheme.

This is like the bird-in-hand policy. You do not know what will happen in future. So whatever is got, fine. To put it scientifically, one Re. received today is more valuable than same recevied/ receivable later. The capital appreciation translates into money ony when one repurchases the units. A dividend declared is ready money. From the point of view of taxation, capital gains are non-taxed. Dividends are subject to dividend distribution tax for debt funds at the aggregate level but not in the hand of the individual. Nevertheless, take a learned decision.

Nifty Index NAV (Rs per Unit)
Dividend Growth
3900 15 15

4250 18 18

Dividend 3 0
15 18
3900 12 14.4

investor got 12+3=15 14.4


Myth No: 6 Diversification reduces risk. An investment into an equity scheme provides adequate diversification. So I need to invest only in that scheme alone to ensure required diversification. Put differently, how much diversification is adequate diversification?

The books say that if one is holding about 15-20 scrips, it is adequate diversification. Most of the mutual funds have portfolios larger than that. So if one buys into a scheme of a mutual fund, it is correct diversification, going by the books. Now what are the risks that one is open to? the strategy/style/asset allocation of a single fund manager. Therefore, it is advisable to have some 3-4 different funds in your investment portfolio.

Have a look at the original malayalam version in Business Manorama dated February 12, 2007

Exchange Traded Funds

This is a new class of products ushered in by the Benchmark Mutual Fund. The concept of ETF is very simple. The AMC approaches those heavy investors in the equities (asset class) to be the contributors. The corpus thus raised is divided into treadable units called creation units and listed on the stock exchange. This group of applicants ensure supply of units anytime. They buy and sell units in the proportion of scrips in the Index and not in cash. The Mutual Fund then sell the portfolio to common investors like you and me who enter and exit in cash mode trading through a broker with the stock exchange. With ETF, you get live NAV than normal MF where you get historic NAV; No tracking error as in Index Funds. Thus ETFs combine benefits of diversification to the full extent, if you are on a broad market Index.

Today we have ETFs on different indices as asset classes.

Read in malayalam the original artice of Business Manorama dated February 05, 2007

Fixed Maturity Plans & Capital Protection Oriented Schemes

Fixed Maturity Plans(FMPs) and Captal Protection Oriented Funds (CPOSs) are the findings in search of excellent products to risk averse investors in the wake of drying up of Assured Return MIPs from Mutual Funds in the Indian context.

Way back in 1993 itself, private mutual funds started innovating and perfected this idea by late 90s when they succeeded in offering debt funds that matched the maturity of the underlying portfolio. The portfolio generally had only one asset with same maturity as that of the scheme offered. Though the fluctuations in the interest rate in the market affected the value of the portfolio, by reserving some 20% to the equity markets fund managers tried to meet investor expectations. The trial and error finally led to force SEBI to issue formal guidelines to offer FMPs and CPOSs.

FMPs do not offer any capital protection at all. FMPs, the objective is return generation whereas in the case of CPOS, the Fund Manger tries to protect the Capital , but not guranteed. The debt instruments needs to get compulsorily credit rated for inclusion in the portfolio. They use Options and Futures to achieve this end. As the derivatives market is in the experimental stages in India, the coming years will open flood gates of opportunityies to those who seek a bit more than returns from debt funds.

See the malyalam version in Business Manorama dated 29th Jan 2007

Index Funds - India

Index Funds are those having portfolio that closely mirror that of the underlying Market Index. For Example, BSE Sensex is a popular equity market index. A fund that closely follows this index will have exactly the same scrips in the same ratio in its portfolio as that of the index. The Portfolio Manger does not do great research to identify the scrip that way. The composition of the portfolio undergo change when he gets dividend/bonus/rights from these companies. Tehn he does necessary purchases/sales to maintain the proportion as that of the Index. The Portfolio manager also does purchases/sales when he faces redemption/sales of fresh units for maintaning the portfolio proprtion. This is based on the Efficient Market Hypothesis that Nobody can Beat the Market. they are passively managed as compared to their equity counterpoarts in the industry.

Almost all MFs have Index Funds. They are common man's investment vehicle; One can easily compare with the Index and make sure whether the fund manager has performed or not.

Look at Business Manorama dated January 22, 2007 for the related Malayalam article

ULIP For Tax savings;Accompanied by Pension Funds

ULIP of UTI MF has been a path breaking product for lower Sum Assured strata. With more money into investments than the Insurance based products, it carved a niche for itself in the Indian Investorscape from 1976. However, the power of marketing may push this species from mutual funds into oblivion. Read the related Malayalam article in Business Manorama dated January 15, 2007

Tax saving Schemes from Mutual Funds

let me introduce to you the Tax saving Schemes of Mutual Funds(MF). upto Rs.1,00,000 investments in Tax saving MF schemes qualify for Tax rebate @ 20% along with other specified investments. There are 3 type of such products from MFs.
1. Equity Linked savings Scheme(ELSS)
2. Uint Linked Insurance Plan(ULIP)
3. Pension funds

Some MFs have multiple ELSS offerings Like HDFC, Principal and UTI. These investments can be repurchased after 3 year lock-in-period only. Otherwise the normal term of investment is 10 years in certain cases and some are Open ended. These schemes are useful as a savings instrument as also a tax saving vehicle.

while investing in any MF, one sholud look at the expenses charged from the investor in terms of initial expense(if it is a NFO), entry load, exit load, fund management expenses. These are all legally valid charges. But is the extent of cahrges warranted? There is no uniformity among funds in charging the customers. some funds charge loads 2.25-2.5%, when some others of same class charge 1.75-2.25%. It is here, the investor should think for himself. Rs 25 NAV fetches 0.9564 unit with entry load where as 1.00 unit without entry load. after 10 years, assuming that you are getting 12% compounded annual growth rate, your investment Rs 25.00 would have grown into Rs.71.02 or Rs. 77.65 depending on whether you got fraction of a unit or a full unit initially.So prefer a no-load fund; if not go for a exit load and not entry load.

When it come to size, it really matters. A very large fund is better than a small fund with same number of unitholders. The large fund can absob scale of economies by sheer size. market shocks mostly get absorbed without affecting the NAV badly. Go for a fund with large corpus than a small corpus.

When you are making an investment for long term, like 10 years, one can be a little lax on the service quotient.




You can read the related Malayalam article in Business Manorama dated January 08, 2007

MFs: Good Prospects

Mutual funds being a link between the savers and investors, are placed at a strategic position in a nation's economy. The MFs give a standard portfolio to investors for risk diversification.The fund managers deploy different investment strategies and styles, research methods etc.. to deliver good returns irrespective of the market fluctuations. Ordinary investors lack the capital,knowledge, experience and capacity in terms of fund management. So far there are about 30 MFs registered under SEBI offering more than 650 products. http://www.amfiindia.com/showhtml.asp?page=mfindustry

The NAV is published by evening 7.00pm on the website of the AMFI to eliminate any manipulation of the data on csah flows from/to the funds.
Tax saving schemes are generally on sale across the months, but particularly in January-March the last lap is available for investors to complete their shopping for the current fiscal. In the early weeks of Jan 2007, UTI, Canbank, Optimix (from ING Vysya) are in the market with fresh products among others. MIN was made mandatory from 1st Jan 2007 and subsequently replaced by the budget 2007 by PAN. You can read more on MIN from http://www.amfiindia.com/

Malayalam version of this article appeared in Business Manorama dated January 01, 2007