Investment in Mutualfunds

Saving and investing through Mutual Funds

Traditionally , Indians invest in real estate , gold and fixed deposits and it is only in the recent years that Equities and Mutual Funds have attracted the investors’ attention. Our pension funds have just started investing in the Stock Market. Still there is a long way to go before every investor has a stake in some mutual fund or the other, directly or indirectly.

Year after year MF AUM (Asset Under Management) is increasing 20-30 percent. I am not an expert on Investments or Mutual Funds but I am trying to learn the ropes as I go along , over the past 10-12 years. This just an attempt to share my experiences for investors starting out now; a primer in Mutual Fund Investing.

Why Mutual Funds

Everybody hears stories of people having got excellent returns from investment in the share markets. But unfortunately they also hear stories of the big crashes in the stock markets and crores of rupees being wiped out in a day. There are people whose life times savings have shrunk to one fifth or one sixth of the original capital. Is it worth the risk ? Investing in mutual funds helps to mitigate the risks involved in direct investment in equities.

If you need to cross a lake, you may just  put on a life jacket , pack something to eat and drink , and set about to “row row , row the boat ,gently down the lake” . But if you need to go into a sea , where there are too many unknowns and too many risks like winds and waves, hurricanes and Icebergs , it is better to look for a ship equipped to negotiate through all kinds of obstacles. Also you need an astute Skipper and a navigator.

While an investor can easily understand financial instruments like fixed deposits and bonds to invest on their own , Equity is a different kettle of fish. If one is not careful, a financial tsunami can wipe out the entire capital. So you need a qualified fund manager backed up by a battery of research assistants with all technical and tactical tools they can muster.

So, if you want to undertake a voyage you need to find a good ship and a good skipper. The Mutual Fund Scheme is the Ship and the Fund manager is the captain of that ship and there is a qualified and experienced crew to assist him.

Next question is how do you select one or two out of the myriad number of schemes in the market. Every day there are new schemes and offers announced to attract investors. Here, we need to understand the idea of risk reward chart.

Risks and Rewards

Higher the risk, higher the reward. Debt funds are like open ended fixed deposits . They give a low return but always a positive one. The Debt / Liquid MFs invest in Govt bonds and such instruments which give fixed returns.

The next in order is Hybrid Funds that invest in Equities and Bonds in a fixed ratio. Depending on the ratio they could be equity heavy or Bonds heavy. Suffice to say that equity oriented Hybrid funds carry higher risks and they also offer higher rewards.

Next we have diversified , large caps followed by diversified mid cap funds. There are also multicap mutual funds which fall somewhere in between. Lastly, we have the sector specific mutual funds. There are times when investors are bullish on a particular sector like technology, pharma or say banking , AMCs(Asset management Companies) launch sector specific schemes to take advantage. But when the tide turns, these happen to be the most affected schemes. To give an example, in 2005-6 bull run, IT funds gave more than 100 % returns in a year and in the crash of 2008, it is the power and infrastructure MFs which saw a huge downturn. You can see the chart of reliance power and infrastructure MF. The scheme was sold with a lot of promise in 2008 and crashed with every dip in the market. An investor who had entered in 2008 would have hardly seen any gain till 2016. This may be compared to the performance of a typical diversified equity MF. HDFC top 100. It can be seen from the chart that from Rs 10/ in 1998, it has steadily rose to Rs 540 in 2018; a return of 50 times in 20 years.

Reliance Power and Infrastructure Fund

HDFC Top 100 MF

It doesn’t mean that sector funds are to be avoided altogether. The risk must be understood correctly and a small percentage of the total capital , say 10% can be invested in such schemes.

How is MF Scheme judged ?

Primarily , a scheme is nothing but the composition of underlying equity assets. A  scheme buying risky equities is risky and one buying stocks of a solid company like blue chips are safer.  The performance of a Scheme is judged against its bench mark index . It could be Nifty 50 or BSE 100 or banking Index etc. That’s why a Scheme is said to be performing well even when it gives negative returns. It may have given a return of -5 % when its bench mark index , say Nifty 50 has given -10%. So if you are buying  a Pharma  MF, you should compare it with the NSE Pharma Index to track it’s performance.

New Fund Offers (NFOs)

Earlier the new schemes were called IPOs. People went for these “IPOs” as they cost only rs 10/ per unit compared to older schemes which cost anything like 500-600 rs per unit. The irony is that people never seem to understand that 10 X 500 and 500 X 10 gives the same result. If anything, the Rs 500 per unit scheme just shows that it has multiplied 50 times since inception. Now they are called NFOs as per directions of SEBI.

Why do AMCs come up with NFOs ? There may be a genuine reason or a necessity to exploit some opportunity in the stock market like arbitrage Fund. But mostly NFOs are ploys to attract more investors. Sometimes an AMC has to float a scheme just to match the competitors who have launched a new thematic fund. Theoretically, there are enough schemes in the market to cater for all kinds of investors. Before going for an NFO, one should be aware that the company is planning to start building his “ship” only with the money collected from the investors like you. Then it takes time to deploy the money. So, initially the Rs 10/ will dip to 9.xx before any gains. It is always better to wait for a Scheme to deploy the money and see how the underlying stocks perform.

Steps to Invest in MF.

How to identifies the schemes most suitable to you. Here I make an assumption that the money set aside for investment should be locked in for atleast three years if not more. Unlike premature withdrwal of Fds, premature selling of MFs can prove very costly.

Top Down Approach

Supposing we have 10 L for investment, it would be a good idea to decide how the risk / reard is to be spread. It would depend on your own temperament and appetite for risk. Normally midcaps and sector funds provide growth to the portfolio while balanced MFs and bluechip MFs provide stability. The debt/liquid funds are equally important. Liquid funds are used for temporary parking of money and also as a reserve to be deployed during market downturns. The ratio could be as under :

Sector Funds – 10%

Midcap Funds – 30%

Largecap diversified funds – 30%

balanced funds – 15 %

Liquid funds – 15%

Bottom up Approach

There are a number of organizations that evaluates the MFs and rate them as three star, five star etc. The details are also available on their web sites. Some of these sites are valueresearch org , mutual funds of india etc. They  can be accessed at my web site  under the menu Money —> Investments.

Of course , one gets lots of tips from people dealing in MFs.  But one has to be aware of the fact that there is more mis-selling than genuine ,free, financial advice. So, it is worth checking back from a second source.

Whichever way , first individual Schemes can be  picked and a portfolio be built , keeping in mind the aspect of Risk – Reward.

In the next part , we’ll go about on-line platforms and SIP mode for investments.

 

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