Know which mutual fund suits you the best
Today choice is a problem - whether it is at the time of earning, spending, investing, or insuring. Likewise even while choosing a MF scheme; a plethora of choices often lures us to take inappropriate decisions. Financial expert Mehrab Irani tries to explain the cost price factor associated with a scheme to enable investor make prudent choice.
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 divided 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 (G-Secs) while Gilt Funds invest only in G-Secs. 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.
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 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 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.
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|
|Credit Risk||Very Low||Low||For parking|
|For temporary parking|
of funds - a superior
alternative to Bank
|Short Term Plans||Fixed|
|Short Term||Credit Risk & Moderate Interest|
|Low||Comparatively Low||Opportunistic Superior returns for short term funds||For short term better|
investment in an
inverted yield curve
|Income / Gilt Funds||Fixed|
|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|
|Credit & Yield|
|Low||Comparatively Low||Fixed Return for|
|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|
|Credit, Interest Rate & Stock|
|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
|Global Stock Market and Currency Risk||High||High||For diversifying into difficult asset classes along with assuming currency risk||High unknown and unmeasurable|
risk in expectation of better returns
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
Mehrab Irani has ventured in to writing. His first book titled "10 Commandments for Financial Freedom" would be released shortly.