24 July, 2012

Is MF a good investment option?

This may sound like a question whose time is long past… most invest in Mutual fund schemes and it is known that, for the normal investor, this is definitely a very good investment option.

There are several things going for Mutual fund schemes. One of them is that you get professional oversight for a small fund management fee ( which is about 1%). You get unparalleled diversification, which is possible for as low an investment amount as Rs.5,000/-.  Thirdly, liquidity is assured as the counter party is the Mutual fund and they will redeem the unit at the prevailing NAV. You will not have a situation like in the case of some penny stock, where there is no one to buy the clutch of shares you own.   Fourthly, the investment amount is pretty low. There are different flavours of funds to suit every investment type and risk profile.  What’s more, the equity funds enjoy nil capital gains tax, after one year of investments and debt funds provide far more benign capital gains tax treatment as compared to other fixed income products. All in all, it seems like a winner.

Now, if you get all these served up in a Mutual Fund scheme, what are the costs?  In any product that we procure, including financial products, there are costs involved. If it is a soap, the costs involved are raw material, manufacturing & overhead costs, the company’s profit and the cost of sales, advertising, marketing and distribution. The cost of the raw material, overhead & manufacturing may just be 50% of the final price. All the rest of the costs come in later.

In case of farm products, it is worse. The final price the customer pays is  4-10 times the farm-gate prices! This is a well-documented fact and we pay these prices as there is no other alternative, for the moment.  So, in every industry, there would be costs involved in reaching the product to the end customer.

In case of Mutual funds, for all the convenience it confers, the costs are recovered by way of an expense that the fund charges. Currently, it is capped at a maximum of 2.5%pa of schemes net assets, for equity assets. This is the only revenue for a MF fund house, with which to run the show.  This is expected to go up now by 0.25%.

This means that out of your income, you would be forgoing 2.5%. Is it worth it? That is the debate. Let us examine.

Margin of outperformance - A good fund can outperform the index by a wide margin. As an example, the top 20 MF large-cap schemes have offered one year returns of between 1.28% and -3.99%. Whereas the corresponding indices have given one year performances of -6.5%  to -8.17%. In this case, there is a clear outperformance enough to justify the expenses. However, if one had invested in the next 20, their one year performance were between -4.2% to -7.07%, which do not fully cover the expenses paid.  Hence, to fully recover the expenses, one must invest in good, performing funds. But, performance keeps changing on a monthly, quarterly basis.

It’s not always about expenses, though -  We need to understand a key aspect. It is not always about expenses. In life too, we spend on petrol and car for convenience. Similarly, there are major advantages discussed earlier in a MF scheme, due to which the expenses are justified.  Out performance is one of them. There is just no point in obsessing over this alone, like a lot of people do.

Portfolio review - That does not mean that one should be oblivious to fund performance. Fund performance is very important indeed.  It is necessary to keep track of what is happening in the scheme one has invested.  A review from time to time is vital. Such a review & investigation will reveal,  if there are fundamental changes that  needs to be factored in. Fund manager change is a fundamental change, irrespective of what processes a fund house may have. When a fund is being revamped or repositioned, there can be sweeping changes. Changes can also be in terms of sectoral allocations, cash calls and moving substantially from the core objective of the scheme. In such cases, changes may be required. For this, one needs to keep track. If that is difficult, one needs to take help of an investment advisor.

Asset allocation – Each person’s need is different. The portfolio that works for one, need not be suitable for another.  Hence, don’t just look at five star funds and make the portfolio.  One might end up with a sectoral or small cap fund portfolio, which may not be what would be suitable. Having assets across categories brings down the risk, though it may be tempting to put everything in what seems to be performing today ( it was Gold sometime back !).

In conclusion, Mutual fund schemes offer a lot of advantages like assured liquidity, amazing diversification, professional expertise, ease of management etc.  There are expenses, but it confers several benefits we have discussed about.  Also, if the fund manager is able to beat the performance of the corresponding index and offer that monetary incentive to invest in a MF scheme, so much the better. Many of them do. One will need to do a bit of homework or take help. 

Lastly, MF is a longterm investment. Stay with it & it will be rewarding.

Article by
Suresh Sadagopan, Founder, www.ladder7.co.in  Published in Moneycontrol.com on 20/7/2012

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