The most suitable Mutual Fund for you

Today choice is a problem - whether it is at the time of earning, spending, investing or insuring. There is simply a plethora of choices and many a times the choices actually spoil us by luring us into inappropriate decisions. Many a times, individual rational intelligent persons commit simple mistakes while making investment decisions in common stocks which actually get compounded while investing in mutual funds. And the mistakes start from initiation – at the time of making the investment decision by committing your money to the wrong fund. This article attempts to dissect the different funds available so as to bring to the fore “The Best Fund for you”.

Funds can be dividend based on liquidity - open and close ended or on the basis of asset allocation – debt, equity, balanced, commodity or on the maturity profile of the underlying investment like liquid, income, gilt, equities etc. Without making an attempt to confuse the reader, this article will classify the different schemes as it be most logically understood and required for decision making purposes.

Types of Mutual Funds

Liquid / Ultra Short Term Plans

Liquid / Ultra Short Term plans are best suited for those investors which have a very short term investment horizon ranging from 1 to a few days. Infact, this is not an investment but just parking of the “surplus liquidity” – it’s a superior alternative to a “bank saving account” wherein you will earn higher yield. Although these funds don’t carry interest rate risk but they certainly carry credit risks. The aim of the investor should be to earn accrual interest.

Short Term Plans

Short Term Plans invest in similar kind of instruments as does a liquid fund but with a slightly high maturity profile. Hence, this fund is best suited for someone having an investment horizon between 3 to 12 months. This fund finds its place between a bank savings account and a fixed deposit. These funds carry credit risks as well as some amount of interest rate risk. The aim of the investor should be to earn accrual interest along with some capital gains.

Income / Gilt Funds

Income Funds invest primarily in longer duration corporate papers with some Government of India Securities (GSecs) while Gilt Funds invest only in GSecs. These funds are best suited for medium to long term opportunistic investment in a steep yield curve scenario. Interest rates and bond prices have negative relation i.e. bond prices go up when interest rates come down and vice versa. Hence, timing is critical in this fund. The aim of the investor should be to earn accrual interest as well as capital gains.

Fixed Maturity Plan

A Fixed Maturity Plan (FMP) is for a fixed period of time and hence locks in at the prevailing interest rate for that period of time and therefore does not have any interest rate risk. However, the FMP has a very high “opportunity loss risk” in the sense that if you lock in long term FMP just before the beginning of an interest rate hike cycle then you will lose the opportunity of earning higher yields. Therefore, investment in a FMP should ideally be done at the peak of the short term policy hike interest rate cycle.

Balanced Fund

As the name suggests, a balanced fund invests in both equities and debt and hence balances your asset allocation needs. The name of the Fund is Balance but it is the most imbalance of all the funds as it takes the credit of protecting and shielding your money of all the major investment robbers – inflation, income tax, interest rates, market volatility and asset allocation. The aim of the investor should be to earn attractive returns during equity bull markets and stabilize its portfolio during equity bear markets.

Equity Funds

Equity Funds invest in equity shares. Over a longer period, equities do provide higher return then fixed income because equity is growth capital. However, timing is important in the markets and you should possess the courage of buying during cyclical bottoms and selling during structural tops. There are different types of schemes like large cap, mid cap, small cap, sector funds, theme funds etc. Many new funds and schemes prop up during times of exuberance. Banking Funds will be launched when banking stocks have performed well, infrastructure funds when the infrastructure stocks are rising or IT funds when the technology boom is underway, so on and so forth. These sector funds are simply smart tactics to collect money from the gullible investors. Remember that there is no reason for you or anybody else to believe that they can pick winning stocks or time the markets. Hence, the best solution for any equity investor is to stock into low cost passively managed index funds because year after year they would beat atleast 75% of the actively managed funds and over the longer term in most probabilities beat almost all the funds.

Gold Funds

Gold Funds and ETFs are now widely available for the Indian MF investor. They offer the ease and safety of holding Gold in electronic format as opposed to the physical format. They also offer tax benefits like not subjected to “wealth tax” and become long term in 1-year as opposed to 3-years for physical gold. The investor has to remember one thing that investment in Gold ETF is as good or bad as the price of the yellow metal itself because the fund holds Gold for you and hence your view on Gold is of paramount importance. I am here not trying to predict the future price of Gold because it’s a speculative commodity with no real industrial usage whose value depends on the value of US Dollar, real interest rates in the US which in turn depend on nominal interest rates and inflation over there and then the value of Indian rupee against the US Dollar.

  

International Funds

Nowadays there are lots of international funds on offer like the feeder funds i.e. the Indian fund house just acts as a “postman” – collecting funds from Indian investors and putting it in their international funds. There are also ETFs on foreign markets now available in India. Needless to say, if its difficult to predict Indian markets then it would be more difficult to predict foreign markets. Besides the pure returns from those funds, currency plays a major role – the thumb rue being weaker the Indian rupee against the US Dollar, higher the return to Indian investor.   

Scheme Name	Category	Investment Time Horizon	Type of Risk	Intensity of Risk	Return Expectation	Suitability	Comments
Liquid / Ultra Short Term	Fixed Income	Very Short Term	Credit Risk	Very Low	Low	For parking surplus funds	For temporary parking of funds – a superior alternative to Bank Savings Account
Short Term Plans	Fixed Income	Short Term	Credit Risk & Moderate Interest Rate Risk	Low	Comparatively Low	Opportunistic Superior returns for short term funds	For short term better investment in an inverted yield curve scenario
Income / Gilt Funds	Fixed Income	Medium to Long Term	Credit Risk & High Interest Rate Risk	High	Medium to High	Opportunistic Superior returns for medium to long term funds	For medium to long term opportunistic investment in a steep yield curve scenario
Fixed Maturity Plan	Fixed Income	Medium to Long Term	Credit & Yield Curve Risk	Low	Comparatively Low	Fixed Return for Fixed Duration	As a superior tax saving alternative to Bank Fixed Deposits. Ideally done at the peak of policy interest rate hike cycle.
Balanced Fund	Hybrid - Equity + Fixed Income	Medium to Long Term	Credit, Interest Rate & Stock Market Risk	Medium	Medium to High	Ideal for Asset Allocation	Balance of risk, return, asset allocation with maximum tax advantages
Equity Fund	Equity	Long Term	Stock Market Risk	High	High	For long term wealth creation	Moderate Risk for superior return – higher risk and tax adjusted return
Gold Fund	Commodity	Long Term	Commodity & Currency Risk	High	Medium to High	High risk for higher inflation adjusted returns	For betting on the movement of a commodity and currency
International Fund	Primarily Equity	Medium to Long Term	Global Stock Market and Currency Risk	High	High	For diversifying into difficult asset classes along with assuming currency risk	High unknown and un-measurable risk in expectation of better returns

Conclusion

To conclude, there are many simple and avoidable mistakes which investors mutually commit while investing in mutual funds. Simple logical things work far better in the market place rather than complex algorithms, theorems, valuations principles, DCF etc. Returns from investment come only because of two numbers – cost and selling price. Through this article I have tried to explain the cost price factor by letting you know which is the best fund for you. There is no other place to test your virtues than the market – be it common sense, logical thinking, patience, perseverance, mental balance, emotional intelligence, performing under stress etc. All the qualities which make a successful human being will be tested by the market –it has its own method of finding and exploiting human weaknesses. Investing is not about beating the market or anybody else, it’s simply beating your own self, your own negative traits and once you are able to master your own self and become a complete human being, then only you would also become a successful investor. Articulate your investment goals, know your time horizon, recognize your risk appetite, understand your need for income and growth, invest regularly although it may be in small lots, do your thinking and research and after doing it don’t panic just because the market went against you, accept your mistakes and flaws and follow the above mentioned simple rules and principles to select the best suited fund for you. Stop making others like the mutual funds, portfolio managers, brokers, distributors, rating agencies, media etc rich with your hard earned money. If you follow these simple principles then you would be able to generate above average return from your investments many times putting the best fund manager to envy!

All the best.

The Best Fund for You

Do you know which is the best mutual fund (MF) investment for you? Have you ever known what is the actual return which you get from your MF investments? If you believe the difference between your sale and purchase NAV is the return which you earn from MF investments then your belief is far from truth – that is just the arithmetically correct return which you earn from the fund but certainly not the best return which you could have earned from your MF investments. There are numerous factors which affect your return from MFs. So, to find out which is the best fund for you we have to consider the various “expenses of investing in funds” which are as follows:

Loads

Entry and exit loads are one of the most punitive charges on your investments which eat into your money at the very source of the investment decision – whether at the time of buying or selling. While MF schemes are not allowed to charge entry loads but they very well charge exit loads – these are nothing but the charges which you pay for selling your MF investment. This is ridiculous as it attacks the very foundation of “open ended MF” and “daily NAV” – if the fund is really open ended than why does it need to charge you for exiting or selling the fund. While the MF or the Distributor will say that it is for “discouraging” short term investments in the fund, the prime reason for “exit load” is to protect the MF against the compensation which it has already paid to the distributor virtually from its own pocket since “entry load” is not allowed.

While “entry loads” are not permissible in MF schemes but they are very much allowed in “Portfolio Management Services” offered by MFs as well as other entities and other investment options like “private equity”. The “entry loads” vary from anywhere between 100 to 400 bps. Entry Loads can be the worst robbery which a portfolio manager can inflict on your investments because it takes away money from your pocket even before it is invested. For example, assume the entry load of a fund is 4%, what it actually means is that the fund will invest only Rs.96 (100 -4) and hence has robbed you of Rs.4 or 4% even before that money could be profitably invested. This is pure robbery of your investment funds even before a penny is invested!

Fund Management Fees   

Every fund has “fund management charges” which in essence is nothing but the fees for managing your money. It is the right of the fund manager to charge you for managing your money as this is his bread and butter. However, it is his duty to transparently disclose such charges. However, the problem is that most of the time these fund management charges are not properly disclosed by the concerned funds. For example, a typical MF factsheet will disclose the loads but it’s very difficult to find the “expense ratio” which is nothing but the fund management fees. The irony of the fact is that most of the investors are not even aware that there is something like expense ratios or fund management fees because the NAV which is declared by the Fund house is “net” of such charges and a breakup of the NAV is never given. 

The other problem with fund management fees is that it is discriminatory, particularly in the case of Debt Funds. This is because generally a very high “expense ratio” is charged in the case of duration based debt products – the common rule being, the longer the duration of the fund, the higher the fund management fees. The logic of the fund house might be correct as higher Fund Management expertise is required to manage a high duration product (like an Income or Gilt Fund) as opposed to an accrual product (like a Liquid Fund). However, the problem for the investor is that the high expense ratios simply “eat into” the interest component of a Debt Fund leaving the “Net Portfolio Yield” of a “high duration high fee Debt Fund” lower than that of a “low duration low expense accrual fund”. For example, if the interest yield of a liquid fund is 9.2% while the expense ratio is 20 bps, the running yield accruing to the investor is 9%. Now, compare this to a Gild Fund with an interest yield of 8.3% and expense ratio of 150 bps leading to a dismally low running yield of just 6.8%. Simply put, the Gild fund is under yielding 220 bps (9.0% - 6.8%) and hence if it has to beat the liquid fund then it has to invariably generate “capital gains”. In effect, unless the fund is able to generate capital gains, it would miserably fail to beat a pure accrual product leaving me wondering as to whether it was justified for the investor to take high risk in a long duration fund paying extra fees for higher risk and volatility in effect to earn lower return in the end. Don’t forget one thing; in the investment world under performance does not come cheap, the investor has to pay heavily for it.     

Veiled Charges

PMS and private equity products often do not clearly disclose all the charges like set up costs, marketing costs, brokerages etc. Many a times, broker driven PMS products charge low management fees and make it up in high brokerage charges. This also encourages them to churn the portfolio because whether the churning makes money for the investor or no, but it invariably does make money for the broker fund manager.

Wealth management Fees

With MFs doing away with the “entry loads” its important for an investor to properly compensate the MF Distributor or the Financial Planner. Most Wealth advisors offer two kind of models – an advisory model which charges a flat fee on the total assets while a transactional model that charges no general fee. However, in such cases, the wealth manager earns from product commissions. Generally speaking, transactional model is better for a “debt oriented product” because the variation in the return is contained while advisory model would be superior for an “equity oriented product” since the disparity in return and performance can be high.

Taking advantages of the discriminating Tax Laws

Remember that Income tax reduces your gross income; interest on loans (on revenue expenditures / bad assets) diminishes your net incomes and inflation eats out your remaining income. And tax laws are discriminating – the more you work for your money, the more you pay in taxes while the more your money works for you, the lower you pay in taxes. You must be aware of the discerning tax laws so as to take maximum advantage of it. Remember the following general rules while planning income tax on your investments:

Ø  As a general rule, equity oriented investments are less taxed than debt oriented investments.

Ø  Long term capital gains tax is most probabilities is lower than short term capital gains tax.

Ø  Tax free debt investments usually offer higher after tax yield to the investor in the highest tax bucket as compared to taxable fixed income instruments.  

Ø  Because of the set off provisions in the Income Tax laws, losses of unrelated investments can be set off against gains from unrelated investments. The moot point is that it should be profits and losses on investments or capital gains / losses and not income from other sources like interest income. For example, the short term capital loss on equities (direct or MF) can be set off against gains from liquid funds. This is ridiculous as equity losses are allowed to be set off against liquid fund gains which is nothing but interest. But, if the taxman wants to give you this benefit then just embrace it with both your hands. However, the important point to keep in mind is that the return from liquid fund should be in the form of a capital gain and not dividend. Now, although the nature of the return earned on a liquid fund or a bank fixed deposit is same – accrual of interest – but if somebody would have invested in a bank fixed deposit he would have not got this tax set off advantage on it because the bank fixed deposit earns interest and not capital gains. Another illustration of unrelated asset set off is loss from a commodity like gold can be set off against gains on real estate and vice versa. So, it’s not always that you work for the taxman, sometimes the taxman also works for you, its only that you should know how to convert “tax losses” into profits for yourself.      

Ø  Dividends on debt oriented funds are taxed at a significantly lower (less than 50%) rate as compared to capital gains. Hence, the taxman is again giving a tax arbitrage without any real logic and hence it would be prudent to invest in dividend paying debt schemes as growth schemes. As a general rule, if you have any kind of capital loss to set off then invest in growth oriented debt schemes or else you are better off investing in dividend oriented debt schemes.

Dividend Temptation

You may be advised by the MF Distributors and marketers that a fund has declared dividend and it is trading cum-dividend and therefore take the advantage of earning free dividends. But, there is no free lunch in this world – particularly not in the world of investments and mutual funds. The dividend which a fund pays to an investor is immediately reduced from the NAV of the fund. So what is the sense of the dividend when on one hand you receive the cash and on other hand your NAV falls by that much amount? On the contrary, I would say that don’t invest in a fund which has declared lofty dividends because that is against your purpose of investments –you are entrusting your money to the Fund Manager to manage it on your behalf and not to return back to you! (unless ofcouse you require regular income in the form of dividends).

Conclusion

Every unsuccessful investment by an investor profits somebody else like the company promoter, mutual fund house, broker, investment advisor, mutual fund distributor, financial planner, fund & credit rating agencies etc. Therefore, stop making others rich with you hard earned money.  Always bear in mind that finding the next best performing MF scheme is a zero sum game, simply put a derivative of the “law of averages”. Its hard to wait for something which you know might never happen, but it’s even harder to give up on something which you know is certainly going to happen. Remember that nobody can time the market or select the next best performing fund. The probability of succeeding in timing the market or selecting the next best performing fund is undoubtedly the same as shooting a spot in the dark. So, rather than trying to venture into all those risky adventures which are inadvertently going to make you lose, invest in the best fund. And the best fund for you is a no exit load index or large cap Fund with minimum expense ratios and fund management fees as also no unnecessary veiled charges while taking advantage of the discriminatory tax laws.    

SIP – Systematic but not Safe Investment Plan

SIP or Systematic Investment Plan is a very popular term promulgated by mutual funds, their distributors and financial planners. SIP is the connotation for Systematic Investment Plan which is generally marketed as a safe and sure route of investments in equities to outperform the markets and create wealth over the long term. SIP is certainly safe for mutual funds and distributors because they get committed continuous money for the long term on which they can earn fees and commissions. It is also safe for the financial planners to recommend because if anything goes wrong then they can blame the SIP system. But, however is SIP safe for an investor? This article attempts to examine and bisect SIP in a manner probably never done before.

What is a SIP?

SIP is nothing but a systematic regular investment plan, mostly monthly or quarterly, of a particular amount in a mutual fund scheme. It is similar to a bank recurring deposit. It allows an investor to deposit small amount at regular periodic intervals in place of a single heavy one-time investment.

Benefits of Investing through SIP 

The major benefits of investing through SIP route are as follows:

Ø  Rupee Cost Averaging

This is supposed to be the primary benefits of investing through the SIP route which has made it so popular among investors. What is the cardinal principle of buying anything in this world – buying when the price is low. Rupee cost averaging simply does that by automatically buying more when the price is low and purchasing less when the price is high. This is the primary advantage of a SIP on which it is being sold and marketed – but does this really benefit the investor – read on.

Ø  Regularity of Investments

SIP regularizes investments by making it a mechanical boring process which is what it is supposed to be. It removes human judgment from the decision making process. It instills discipline in the investor and helps him stay focused, investing regularly for the long term.

Ø  Power of Compounding

Some term compounding as the “eight” wonder of the world and it really is. Very few people realize how powerful compounding is over long periods of time – small items compounded regularly over longer periods yield big difference in the final results. For example, Rs.5000 invested monthly at a 10% p.a. return over a 30 and 35 year period would accumulate to Rs.1.13 crores and Rs.1.90 crores, respectively – a massive difference of Rs.77 lacs. Hence, just by starting 5-years earlier, a person would ultimately be able to accumulate Rs.77 lacs more – that is the power of compounding.

The first one i.e. rupee cost averaging is the general perceived benefit of investing through a SIP route – the other two ones are advantages of investing through any regular investment method. Now, let us consider that whether is SIP really superior to lump sump investments or not.

SIP – Is it really superior to lump sum investment 

Is SIP always superior to lump sum investment option? Certainly not – SIP is not always a better method than the lump sum investment option. Why? The Sensex is around 17000 levels today and if you know with certainty that it is going to become 30000 after one-year than you would obviously be better off buying your entire investment quantity today at probably the lowest value rather than keep averaging upwards month after month through the SIP route. On the other hand, if you knew that the Sensex is going to go down to 12000 in the next one-year then forget SIP or lump sum, you would be richer not investing at all in equities. Therefore, SIP is not some magic that it will outperform lump sum investing method or always give positive returns, even during the long term. So, what are the conditions under which SIP works? The next section examines that.

Conditions under which SIP would yield positive results

SIP route would ideally yield positive results only under the following conditions:

Ø  Bull or Rising Market

SIP would yield positive results in a bull or rising market as every new purchase, although made at a higher cost, is ultimately valued at an even higher price. However, as seen earlier, in such a case it would be wiser to buy the entire investment lump sum rather than keep “averaging upwards” through the SIP route.

Ø  Volatile but rising market

SIP should finally perform well in a volatile but ultimately rising or bull market. This would be the market kind in which the “rupee cost averaging” would work most favourbly for the investor as the volatility would lead to the best possible average price. The final rising or subsequent bull market would ensure that the end price is higher than the average price.

Ø  Market in Median range, corrects downwards and then moves up

This would be another case in which SIP would perform well and in all likelihood better than initial lump sum investment. This is because the investor will get the assistance of the intermediate correction to “lower his average cost”.

But then does this mean that SIP works under all market conditions. Certainly No. So let us now examine the market conditions under which SIP would not work.  

Conditions under which SIP would not yield positive results

SIP route would not work under the following market conditions:

Ø  Bear or falling Market

SIP would not work and infact yield negative returns in a bear or falling market as every new purchase, although made at a lower cost would eventually be valued at an even lower price. In such a market scenario, SIP might outperform lump sum investments as the investor will get the benefit of “averaging downwards” but the investor will still lose money – I believe it should be the endeavor of every investor to make money by investing and not simply “lose less”.

Ø  Sideways Market

SIP would not work in a sideways market as you will not get the benefit of rupee cost averaging and the final value would be closer to the average cost. In a sideways market, the difference between the performance of SIP and lump sum might not be material.

Ø  Market in Median range, moves upwards and then moves down

This would yet be one more case in which SIP would not perform because the investor will actually be hurt by the SIP as he would be “averaging northwards” while the final value would be much lower due to the subsequent market correction. Infact, in this scenario, lump sum would perform much better than SIP as it would not be subjected to the “negative effects of higher rupee cost averaging”.

Therefore it has been proved beyond doubt that SIP might not always be a best investment route. So, not let us move forward and examine when would it be ideal to invest through SIP or when just buy it lump sum.

Market Condition	Superior Investment Option	Comments
Rising or Bull Market	Lump sum	Since the investor buys lump sum at a lower price rather than “averaging upwards” through the SIP route
Falling or Bear Market	Neither of the two	Simply because in a bear market an investor is going to lose money in equities – whether SIP or lump sum
Sideways Market	Indifferent between the two	Both will lead to somewhat similar results since there is neither any benefit nor suffering due to using either of the methods
Market in Median range, corrects downwards and then moves up	SIP	SIP would in most probabilities perform well because the investor will get the assistance of the intermediate correction to “lower his average cost”
Market in Median range, moves upwards and then moves down	Lump sum	Lump sum should in most likelihoods perform better since the investor will not average higher

Common misconceptions about SIPs

Misconception: SIPs generate higher return than lump sum investment

Truth: As explained earlier, this is just a misconnection disseminated by vested interests like mutual funds and their distributors. SIP can be as good or as bad as lump sum – in all depends on which market condition you are in.

Misconception: SIPs always generate positive return over the long term

Truth: There can be nothing further away from truth. This statement is made under the assumption that equity markets always go up over the long term. If for whatever reasons equity markets don’t go up over the long term then there is no way in which SIP would be able to generate positive return. And if equity markets indeed always go up over the long term, then whether SIP or lump sum or any other method, the investor will always get positive return.

Misconception: SIP would always give positive return because of “rupee cost averaging”

Truth: This is a stupid statement. Rupee cost averaging can work in the investor’s favour or against him, depending on which market condition it is. If it’s a bull market then rupee cost averaging actually works against the investor and vice versa.

Conclusion

SIP works on the principle of regular investments and brings the power of compounding to your forth. It removes tensions and uncertainty from your investment plan by making it a mechanical boring process. It inculcates the habit of regular savings and does not encourage timing and speculation in the markets. All these are correct and accepted facts. But, don’t forget that SIP is just another method of investing, it is a vehicle not the final destination – it may pass through straight road or bumpy roads – it may lead you to your destination is a lesser or sometimes higher time frame – and sometimes it may even not lead you to your destination by derailing your plan. SIP is just a method of getting on to the investment vehicle to reach your destination – if the vehicle you choose is incorrect – whichever method you may get in- there is less likelihood of you reaching your destination. Therefore, the next time when a mutual fund or distributor or financial planner advises you that SIPs are the safest route to invest in equities then remember that they are not telling lies – it is safest route but not for you the investor but for their own selves.