Investing situations that cause Panic

Mutual Funds have emerged as a very useful and tax effective vehicle for investors with different risk profile and time horizon. The added advantages are the variety of options, flexibility and the simplicity with which one can invest in them. It is, however, imperative that a proper care is taken at the time of selection of schemes.

If one follows certain basic principles of mutual fund investing, the chances of success improve considerably. Besides, having the right allocation in equity and debt funds helps in achieving different investment objectives over varying time periods.

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It is heartening to see marked improvement in the quality of decision making process thanks to the initiatives taken by the mutual fund industry and emergence of new breed of quality advisors. Besides, at least a section of investing public has started taking responsibility by participating in the decision making process. However, one still comes across certain situations where illogical decisions are made. Besides, there are certain areas where improved knowledge can make a difference in terms of investors deriving the true benefits of mutual fund investing.

Let us analyze some of these situations and see how an investor should deal with them.

Temptation to invest in a fund just before the dividend is paid:

There are investors who believe that investing in an equity fund, just before the dividend payment, is a smart strategy. Of course, the major attraction here is the percentage of dividend as well as the tax-free status of dividend. If you are one of those, think again.

First of all, it is important to understand that if a fund declares 100% dividend, it is paid on the face value i.e. Rs 10 in most cases, and not on the NAV. Secondly, the NAV of the fund, post dividend payment, gets reduced by the dividend amount. For example, if the NAV of a fund paying 100% dividend is Rs 40 on the record date, the NAV will come down to Rs 30, post dividend payment.

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In other words, you receive a part of your own capital back in the form of dividend and not a gain, as is commonly perceived. At the same time, since the dividend percentage and not the quality of portfolio or the composition of it, becomes the main criteria, there are chances of investing in a fund that may not merit an investment otherwise. It is important to understand that dividend payments by the funds are a process of distributing gains to its unitholders and only those who remain in the fund for a considerable period benefit from it in the real sense.

Then there are investors, who believe that investing in a fund with high NAV impacts their dividend receipts. The truth, however, is that the dividend percentage is generally decided based on the current NAV, gap between two dividend payments and the philosophy of the fund house with regard to the dividend payment. For example, it will be wrong to assume that two equity funds with the NAV of Rs 20 and Rs 40 respectively, will declare the same dividend. It is more likely that the fund with the NAV of Rs 20 may pay Rs 5 per unit as dividend and the fund with the NAV of Rs 40 may pay Rs 10 as dividend. In that case, the dividend received in the hands of investors for both the funds will be the same.

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Therefore, to invest in a fund wherein the immediate dividend payment is the main attraction may not be a smart strategy after all.  The right way to invest is, to carefully select funds, based on the quality of portfolio, consistency in performance as well as suitability of the fund as per asset allocation.

Inconsistent Performance of the fund:

It is important for a mutual fund investor to know what to expect in terms of returns and how to measure the performance. While all of us hope that the fund that we are invested in should continue to do well consistently, in reality there are certain time periods when the fund’s performance may slip.

While one need not panic every time the market turns volatile, it helps if one is prepared to deal with such a situation. For a long term investor and regular investor, fluctuations provide opportunities that one time and casual investors miss out on.

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If the fund losses ground in a falling market, it is not much cause for concern. However, if the fund goes down when others are going up, it can be a warning signal. The consistency in the fund performance is the key for the long term success. For example, a fund rises 50% in one year and falls 30% in the next year. At the end of the 2 years period, an initial investment of Rs 10000 will become Rs 10,500.  On the other hand, if the money had been put in a fund that rose 30% in the first year but dropped only 10% in the second, the investment would be worth Rs 11,700 - a difference of around 12% over a period of two years.

If required, one should not hesitate to get rid of non-performing schemes. By doing so and re-investing the money in schemes that have better quality portfolio and track record, one can enhance one’s chances of improving the returns over time. It is important to know that getting emotional about non-performing investments or waiting endlessly in the hope of recovering losses can be a fruitless exercise.

The size of the fund grows too large:

It is commonly believed that a fund can become victim of its own success. In other words, it can become too unwieldy to manage efficiently. However, it is important to look at the fund size in the context of its nature and investment style. A fund’s performance can suffer in case it outgrows its investment style. For example, a mid-cap fund where the success depends on how effectively the fund manager does the stock picking, the large size of the fund may force him to make certain compromises in terms of the investment approach.

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However, the fund size does not matter for some of the fund types. For example, it is much easier for a debt fund manger to manage a large fund compared to an equity fund. Considering that the size of the debt market is much bigger than the equity market, there are plenty of options available for the fund manager.

The fund gets a new Fund Manager:

This is generally a very tricky situation and dealing with it requires proper understanding. By pressing the panic button and redeeming your holdings immediately from the fund may not be a wise thing to do. There are certain factors that need to be considered like the type of fund one is invested in, investment philosophy/style of the fund house and how long the fund has been in existence. Let us analyse each of these factors and see how they could impact your decision.

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Firstly, if you are invested in an index fund, a dividend yield fund or in a fund wherein the rules regarding what the fund manager can do are clearly spelled out, change in the fund manger may not have much impact on its performance. Secondly, it is important to look into the fund management style of the fund house especially how much independence is given to the fund manager. Most big fund houses usually have guidelines that a fund manager must conform to. Besides, in some fund houses, the process of investments is overseen by an investment committee. Thirdly, if the fund has been in existence for a relatively shorter period, change in the fund manager may not make much of a difference.

Even if becomes clear that the former fund manger enjoyed considerable independence, a decision to sell off the holdings should not be taken without finding out as much as possible about the new fund manager. If he ran a different fund, check the fund’s track record. Ideally you should give a new fund manager at least six months or so to prove himself. If at the end of that period, the fund has done poorly compared to its peers, it’s the time to act.

 - Hemant Rustagi

 The author is CEO, Wiseinvest Advisors Pvt. Ltd. He can be reached at hemant.rustagi@moneycontrol.com

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