Things to know about mutual funds

In a previous article , we have seen about famous investment myths about investments in general. There are also misconceptions about mutual funds prevailing among the investors. Let us dig through them and understand how they are misconceived.

1.Diversified funds invests across all sectors.

             Ideally an investor would expect the fund to be invested in all sectors . However the funds usually have a bias towards large cap or mid cap or small cap. They have significant exposures in one or two sectors as they take sectoral bets. So investor should not go by the label "diversified fund". One should look at the funds past track record and identify what are the funds major bets over the past. So long term funds are a better option than new funds.

2. Mutual fund dividends are same as stock dividends.

               Investors tend to believe that mutual fund's dividends are same as stock dividend. However it is not true. When a mutual fund declares dividend in a scheme, the dividend is deducted from the fund's NAV and it does not come free to investors.

            Eg. A fund with 40 rs nav, when declares a dividend of 3 rs , the nav of the fund reduces to 37.

               So an investor can opt for dividend-yield funds if he intends to generate minimum cash flow from his investment on a regular basis.

3.SIP always scores over lumpsum investing.

               Though it is true that SIP(Systematic Investment Planning) would bring in discipline in investment and would lead to regular contribution, SIP does not beat lumpsum investing in a rising market. The major benefit of SIP - cost averaging does not hold good in a long term rising market. SIP works best when market has upward and downward cycles alternatively.

4. Lower NAV is cheap to buy

          It is advisable to go for a old fund with a good track record rather than buying a new fund offer at a lower NAV. A detailed analysis of this given here.

5.FMP returns are fixed 

              Though the name Fixed Maturity Plan suggests fixed returns, in mutual funds, as per SEBI , no fund can assure the investor of fixed return. Hence even FMP's return can turn negative if the interest rate scenario changes during the tenure or inflation rises during the tenure.

          So as an investor you should know all features of asset class (pro's and cons) before making your investment. So i hope this series of information is educating you in your investment journey.

What are Gold ETFs?

As a country, India is the largest consumer of gold and Indians value gold very high than anyone else in the world. In the past few years, apart from physical gold, other channels of gold investment have opened up. One of the most interesting option is Gold ETF. So what are GOLD ETF?

Gold ETFs are mutual funds which listed and traded in the stock market.All you need is a demat account to buy and sell Gold ETFs. The advantages of ETF as explained in the previous article holds good for Gold ETF too.

While investing in Gold ETF, take into account the following information.

1. Avoid buying Gold ETF funds during the NFO. The reason is during NFO Gold ETF charge 1.5-2.5% as entry load. However when these Gold ETFs are listed in the stock market, you can buy them without entry load but with a marginal brokerage of 0.2-0.5%.

2. Check the expense ratio of Gold ETFs. Currently they are in the range of around 1% for most Gold ETFs.

3. Gold ETFs cost includes cost of annual fees for demat account and online trading account. Remember you need demat and trading account to operate in Exchange Traded Funds.

What should investors do?

Though Gold ETFs reduces the risk of holding gold in physical format, you should take into account the cost(Expense ratio,brokerate,annual fees for trading and demat account) of holding a Gold ETF. After considering both scenarios, make your investment call.

What are Exchange traded funds?

Of late ETF(Exchange traded fund) has gained more attention among the Indian investors. So what is all about ETF?

What is ETF?

ETFs are mutual fund schemes whose units can be sold or bought in the stock exchanges during the regular trading hours. They do not have cut off timings like other mutual funds for buying or selling units. You need a demat account to operate with ETF.

Types of ETF

Passive ETFs - These mutual funds mirror a index and invests in a same set of stocks which comprimises an index. It is similar to index funds.

Active ETFs - These funds invest in a set of stocks that pertain to the mandate of the fund.

How ETFs work?

1. ETF units have two prices - market price and NAV. So usually market price of ETF unit will be at discount or premium to underlying NAV.

2.Investor does not deal directly with mutual fund company for purchase of units, he purchases the units via stock exchange.

3. Direct purchase of units from mutual fund company is done by high net worth individuals or institutions, because the minimum number of units to be purchased will be very high and not affordable by retail investors.

4.By using arbitrage methods, mutual fund company tries to keep the difference between NAV and market price to minimum.

Advantages of ETF

1.ETFs are cheaper than index funds. They have a expense ratio of 0.5 to 1% compared 1.5% of index fund.

2.They can be bought or sold during any time of the trading hours unlike mutual funds where u can purchase only at a NAV which is calculated at end of day.

3. They mimic the performance of underlying index better than the index fund.

Disadvantages

1. You need to have a demat account and trading account to operate in ETF whereas in mutual funds you just need a pan card to invest.

2. You have to pay a brokerage of 0.5%-1% for trading via broker like icici direct,sharekhan etc.

Who can invest?

1. Investors who want to mirror the performance of benchmark indices.

2. Investors who want to invest in asset classes like gold.

What is ELSS?

Most of us during the month of march rush up to our auditors or financial planners for tax planning to invest upto 1 lac which qualifies for tax exemption under section 80 (c) . Most of us end up in paying LIC premium,PPF,NSC,5 year bank FDs and other traditional tax savings instrument. Let us go through one another option available to us - ELSS

ELSS - Equity Linked Savings Scheme is a type of mutual fund which is qualified for tax exemption under section 80 c. Lets dig into more information on this scheme.

Features

1. It is a mutual fund with a lock in period of 3 years. The lock in period of 3 years is much lesser than lock in period of 15 years in PPF and 6 years in NSC or 5 years in bank FD.

2. It is a equity diversified fund and hence the returns over a longer period of time is higher than the fixed income instruments like PPF,NSC.

3. With high returns, comes high risk associated with the investment.Hence if you are an investor who does not want to take any risk with your investment, you can avoid ELSS.

4. You can invest upto 1,00,000 in ELSS for getting tax exemption.

5. You can invest periodically via SIP option and that brings in discipline and cost averaging in your investment.

6. You can opt for dividend option and get some money out of the scheme even during the lock in period. This is not possible in PPF or NSC in a duration of 3 years from investment.

So start exploring the various ELSS schemes in the market and choose a one with good track record and a good rating. You can refer http://valueresearchonline.com/ for fund ratings

What are the benefits of mutual funds?

Of late there is an increase in awareness on various investment products among investors and it goes without saying that mutual funds have got its own share in 4% of Indian household savings.

So why is mutual fund preferred over direct investment in stocks?For a first time investor who doesnt have much knowledge on investments, mutual fund provides numerous advantages.

1. The most obvious reason in favour of Mutual Funds are that you can make an investment even at Rs 100 per month via SIP. You need not be blessed with huge sum of money to invest in mutual funds. Typical SIP amount per month is 1000-2000 in most cases.

2. Professional management of money put in by investors is an added advantage in mutual funds. Most of us do not have the time and bandwidth to place buy and sell orders in markets in a regular basis. It is always better to leave a job to professional fund managers than we breaking our heads.

3. Another advantage is that a mutual funds invests in a good set of stocks and it is not limited to 1 or 2 stocks. Typically a fund invests in 30-50 stocks and hence there is diversification in investment. It also reduces the risk associated with the failure of single stock.

4.Mutual funds (except for ELSS) have no lock in period. They provide ample liquidity to investors.

5.ELSS - a category of mutual funds which is eligible for tax benefits and at the same time can generate better returns than traditional tax saving instruments over a long period of time.

Keeping these in mind, for a beginner in investments, it is always advisable to opt for mutual funds than directly jumping into stocks.

What is index fund?

There are two kinds of investing.

Active Investing

This involves active analysis of the company while investing. It involves answering the following questions

1. How is the company performing?
2. At what price should i buy?
3. What %age of my portfolio, should the stock occupy
and more questions.

Passive Investing

This involves creating a portfolio by simply replicating an already existing system witout any change at all.

Index Fund

Index funds are an example of Passive Investing where in the fund's portfolio is created completely by replicating an index.For eg, nifty index fund will constitute stocks present in nifty in the same ratio as it is in nifty

Advantages

1. The index fund has a lower cost attached to it. Since it has minimal transactions in terms of selling and buying stocks, it has a lower expense ratio. Lower expense ratio reflects in the NAV of the fund.

2. The investment objective is simple to understand and easy to track since its a mirror image of an index.

3. There will not be any change in fund's objective since it is based on index.Today lot of funds are churning their portfolio often.

Disadvantages

1. In the downward market, there will not be any cushion against the fall, since it does not have cash in its portfolio and is always fully invested.

2. When the tracking error(diff between fund's return n index return) is more than 2-3%

3. It can not outperform the benchmark index since it exactly replicates the index portfolio.

Target Investors

It is suitable for investors who are contempt with the broader market returns given by various indices.

How to select a mutual fund?

There are more than 500 schemes in mutual fund to choose from. An investor is fed with too many choice to choose from,but, a wise investor should consider certain criteria before investing in a fund.Lets go through the criteria.

1. Performance

The performance of the fund should be checked against its own benchmark which is mentioned in the fund document. The fund's performance should also be compared against its peers in the same category. A tech fund should not be compared with a pharma fund or a diversified fund.

2.Risk-Return Ratio

The ability of the fund to generate optimal returns for the risk level that fund is taking up. A balanced fund should deliver a moderate return since its risk level is not that high as a equity fund. The equity fund should be able to deliver a higher return owing to its risk taken in investing in equities. There are good indicators for risk-return ratio of a fund.We can see that in the coming posts.

3.Portfolio

To analyse the porfolio of a fund, the should be in existence for a significant period of time.So go for a good track record fund.Check if the fund is a large cap or midcap or smallcap fund and choose a fund which aligns with your requirement of investment.

4.Fund Management

A fund's track record is nothing but the track record of the fund manager. So track his presence in the mutual fund.However fund houses don make a fund reliable totally on a single fund manager, it still makes an impact when a top fund manager leaves a fund.No need for panic redemption when a fund manager leaves,stay put and analyse the fund before and after fund manager's exit and take a decision.

5.Cost

Two funds A and B with a similar returns in the past but with varying costs makes a difference.A fund with a lower costs stands better than a higer cost fund.The cost of a fund is expressed in terms of expense ratio.Go for a fund with lower expense ratio.

What is Monthly Income Fund?

MIPs or Monthly Income Plan would be suiting for retired people who would need a monthly income plan but they have not opted for assured pension during their working life period for various reasons.

Let us go through more in detail about the Monthly Income Plan


Objective

To generate regular monthly income to investors in the dividend plan.

Asset Allocation

Fixed Income Instruments = 80-85%
Equity = 15-20%

Assured Return?

As with mutual funds , the monthly dividend payout is not assured but there are certain good funds which has a good track record of giving monthly dividens without fail.


Taxation

For a person in the 30% income tax slab, MIP scores over other debt products by having a Dividend Distribution tax of 19% instead of 30% in bank FDs.


Suitable Investors

Those who are nearing retirement or attained retirement

To find the list of funds in this category, check out @ http://www.valueresearchonline.com/funds/h2_typecomp.asp?type=1&objective=19

Diversfied funds Vs Sectoral Funds

In mutual funds, there are two common types of equity funds - diversified and sectoral funds. Let us go through the comparison of two funds.


Choice of Stocks

1. Diversified funds invests in stocks of different sectors and industries.
2. Sectoral funds invests only in stocks of the sector where the fund has the mandate to invest. (eg tech sector funds invest only in tech companies)

Risk

1. Diversified funds has a low risk compared to sectoral funds due to investment in various sectors.If a sector performs badly,it can exit from the sector and invest the funds in a better performing sector.
2. Sectoral funds carry a high risk since their investment is concentrated on a set of stocks of a single industry.If the industry performs bad, then the fund will be beaten down heavily. (eg dot com burst in 2000 and recent IT crash)

Who should invest where?

1. A person with thorough knowledge in a sector only should invest in that sector fund.
2. A person with not much of knowledge should opt for a diversified fund and let the fund manager choose the investment sectors.

Time Duration

For all equity investments, regular SIP over a long period of time will bear its own fruit.

Happy Investing!!

What is balanced fund?

Balanced fund are a type of funds which does not take full exposure either in equity or in debt. It invests in both equity and debt in a well defined ratio as per the fund's mandate.These funds are also called as hybrid funds.


Equity Oriented Hybrid Funds

These funds usually invest in the ratio 60:40(equity : debt) or 75:25 (equity : debt). This is suitable for investors who wants to get benefited from the equity market but at the same time would not like to risk his entire money with equites. These funds perform better than equity funds during the downturn in markets and have a better shield in terms of debt component.

In case of downturn, these funds increase their debt component to reduce the impact of falling market in the fund's NAV.Similarly during a bull run, these fund will increase their equity exposure to get benefited from the bull run. So a moderate risk investor can choose this fund to have a balanced return.

Debt Oriented balanced Mutual Funds

The pension funds are typical example of debt oriented balanced mutual funds. These have a big chunk(>70%) of their portfolio in debt instruments. These funds are designed to get returns from debt instruments but have a small portion invested in equities to get that additional kicker return to outpace typical fixed income instruments like bank FDs.In order to get an edge over typical debt instruments and also provide investor an extra bit of return, they have a limited exposure to equities.

So an investor in the age range of >30 who has dependents and who can't take high level of risk, can opt for balanced fund to bring in stability to his portfolio.

Investment Rules

Investment is a simple concept which is often complicate too much by investors. Always "keep it simple" and be "disciplined" in investments. There are certain rules that needs to be followed while investing for a longer term.

1.Identify your short,medium and long term goals.

2. For Short and medium term goals(2-5), park your money in fixed income instruments and avoid going the equity route.

3. For long term goals (>5 years), go for equity investing.

4. Keep it simple in equity investing. Go for good diversified mutual funds with good track record.

5.Ignore hot sectors or stocks which are being most talked about in televisions and newspapers.

6.Invest Regularly. Start a SIP(Systematic Investment Plan) in mutual funds to bring in discipline in your investments.

7.Execute "Buy and Hold" policy. Do not churn your investments often.

8. Last but not least, "Start Early".

Happy Investing!

Tags: Investment

How does SIP operate?

You would have seen recently a lot of ads regarding SIP(s) in your television sets and in websites while browsing. So what is an SIP and how does it work?. SIP is a tool to bring in more discipline to your investments. SIP is a method of investing in mutual funds.

Via SIP you can invest in a regular intervals of either weeks,months or quarters. However mostly SIP are synonymous with monthly investments. Suppose you invest every month say 5k in a mutual fund SIP, how this money is been handled by the Mutual fund. For every 5000 you pay them, they will buy units of the fund in which you are investing.

Units are similar to shares, but it doesn't represent a single company. So now you know that you are alloted units , but how many units will be alloted is based on NAV(Net Asset Value). Suppose if a net asset value of a fund X is 50 rs today, and if u pay 5000 rs , you will get 100 units of that mutual fund.

These NAV are similar to share prices and they are calculated every day. Don bother much about the NAV calculation. So these NAV(s) keep changing every day. So while going for a SIP, you have to specify the date of the month, so that on every 10th (or some other date) the fund will buy units for you for the SIP amount.

Since timing the market is totally not possible, SIP is a more efficient way of participating in the markets. "Buy low sell high" may be feasible for some intra day traders but not for investors, who builds his wealth slow and steady over the long term.

A use case of SIP for franklin bluechip fund from June 2006 to Dec 2006. A SIP of 5,000 on 10th of every month.

Read it as Month---NAV---Units bought
June---91.65---54.56
July---100.86---49.57
August---105.48---47.4
September---110.83---45.11
October ---118.38 ---42.24
November---125.55---39.82
December---127.31---39.27

Amount invested = 5000*7 = Rs 35000
Total Units = 318. 044
Nav = 127.95(as on 14th Dec)
Market Value = 318.044 * 127.95 = Rs 40693

So get started and achieve cost averaging by investing via SIP.

Tags: mutual funds

What to do with MF NFOs?

On an average we saw 2 or 3 NFOs( New Fund Offers) coming up every month last year and the mutual fund agents are there to deceive people by saying that "BY LOWER NAV OF RS.10 U CAN GET MORE NUMBER OF UNITS". Mutual funds are not stocks. THE NAV OF THE FUND DOESNT MATTER. Its the RETURN that matters the most.

Disadvantages of NFOs.

1. You are not sure of the portfolio of the new fund. Only when the fund functions for an year or so , you can get an idea of what kind of stocks does the fund holds.

2. NFOs DONT follow the themes(or) objectives of the fund exactly. Unless there is a unique feature abt the NFO like Gold ETF or RealEstate mutual funds, its not advisable to get into an NFO. Suppose if a theme is a large cap fund, there are n number of good large cap funds already available. So these kind of funds are not very distinct.

3. NFOs are NOT CHEAP. Simply coz the nav is 10 does not mean that NFOs are cheap.

Consider two cases. Suppose if 1,00,000 is invested in two funds for one year.

1. Good track record fund.

NAV - Rs 100
Units - 1000
Return - 50 %

After 1 year, NAV = 150. So market value = 1000*150 = 1,50,000

2. NFO

NAV - Rs 10
Units - 10000
Return - 50 %

After 1 year, NAV =15. So market value = 10000*15 = 1,50,000


As you can see , the NAV doesnt matter, the rate of return matters the most and also the

Probability of existing fund performing better >>> Probablity of NFO performing better and the investor can trust the existing fund keeping in mind its past performance.

DISCLAIMER : The past performance may or may not repeat, but as Sachin in the team gives the indian team psychological strength, a good performing fund in your portfolio will make ur life more secure than an NFO.

Tags: mutual funds

Mutual Fund Pension Plans

In India pension plans are most synchronous with Pension plans that employers provide for their employess. As a component of EPF, EPS (Employer pension scheme) is offered to all organized sector employees by their respective employer. This is roughly around 5% of their monthly basic salary and it earns 8.5% interest on it.

During the retirement period, employees opt for pension and get their monthly pension cheques.Returns of 8.5% in an environment where inflation is 10%+ is not generating any REAL returns. Investors should always look for returns which beat inflation atleast by a 7-8%.

Mutual funds also provide pension plans.These funds come as a debt oriented hybrid funds.The characteristics of these funds are

1. Lock in period of 3 years.

2. Exit load of 3% if withdrawn before the age of 58. This brings in discipline among investors to not to keep meddling with amount dedicated for pension.

3. These qualify for section 80(c) tax benefits. Investment made into pension funds upto 1 lac is tax exempted.For people who don have home loans and are figuring out what to do to fill up 1 lac in 80(c), this can be a very good option where both tax benefits and investment need is also satisfied.

4. UTI and Franklintempleton are the two funds which currently offers pension plans in mutual funds.

5. Past track record of the two funds.Annualized returns since inception as on 13/08/08 for

1. Templeton India Pension Plan(1997 - 2008) - 14.62

2. UTI Retirement Benefit Pension Plan(1994-2008) - 11.18

TIPP is a better choice than UTI's scheme.

So start exploring the pension options in mutual funds and get inflation beating returns from them.

Happy Investing!

Tags: mutual funds

What is expense ratio in a mutal fund?

The expense ratio is the total amount of annual expenses incurred by the fund. It includes the management fee and operating expenses like the registrar and transfer agent fee, audit fee, custodian fee, marketing and distribution fee. The expense ratios of equity and debt funds differ. Since the expenses of equity funds are more than those of debt-oriented funds, the expense ratio on equity funds is greater.As per the regulations of the Securities and Exchange Board of India (SEBI), a mutual fund can charge a maximum expense of 2.5 per cent (equity funds), 2.25 per cent (debt funds), 1.5 per cent (index funds) and 0.75 per cent (Fund of Funds).A fund with lower expense ratio and good returns is a very good since the cost of the fund will not eat up the returns generated.

What is arbitrage fund?

Arbitrage Funds are referred as equity-and-derivative funds. The objective of an arbitrage fund is to capitalise on a stock's price difference between the spot market (cash segment) and the derivatives market (futures & options segment). These funds basically generate income by taking advantage of the arbitrage opportunities arising out of the mis-pricing between the two markets (spot and derivative).

If a stock A has a spot price of 100 and future price of 110, then an arbitrage fund manager sells the stock futures at 110 and buys the stock in spot market for Rs 100 and earns Rs 10 for the stock.

Furthermore, on the settlement day of the derivatives segment, the stock prices in both the markets tend to coincide. So, the fund manager will reverse his transaction - buy a contract in the futures market and sell off his equity holdings in the spot markets - and earn more profits.

Arbitrage funds offer better returns than debt or income funds and their earnings become tax-free after a year. However the concern is if the size of the fund is very large, most of the money would be parked in money market instruments.