Should you consider direct equity or equity mutual fund

Juzer GabajiwalaVentura SecuritiesWe come across many investors who need clarification on whether they should invest directly in equities or via mutual funds. These investors have the perception that it is better to invest in equities directly rather than through mutual funds and the most common arguments or reasons for these beliefs are: It is easier for the amount invested in equity to double than it would be through a mutual fund; some would even say that the latter is not possible. Also due to volatility in share market, it is a more exciting investment experience. This has led us to analyze the similarities between direct equities and equity mutual funds or rather the difference. “Should one invest in direct equities or equity mutual funds”? First of all, you need to understand that from a taxation point of view, equity mutual funds and direct equity have the same structure – there is no difference at all.Volatility: Volatility in stocks is high as compared to volatility in mutual funds. As seen from the table below, we have made a comparison between HDFC Equity Fund (highest assets in equity- Rs. 17,168 crores) with ICICI Bank and Maruti Suzuki, which are the top equity holdings in the same scheme’s portfolio. ICICI Bank was down by 10.55% and Maruti Suzuki was up by 49.07% in the last one year; whereas HDFC Equity Fund is down by 0.57% in the last one year. Hence, in stocks you can see wild volatility whereas in mutual funds, the volatility is much less. Given below is the return chart reflecting the volatility over different time periods for illustration.

Returns as on September 28, 2015.Comparing apples with oranges: When one invests in mutual funds, one buys a basket or portfolio of stocks. A typical mutual fund portfolio will consist of 20-25 stocks, each with their own price movements, which may sometimes cancel each other out. The movement of a single stock, on the other hand, can be clearly captured. Thus you cannot compare the two investment avenues. If at all one wants to do a comparison it has to be a complete portfolio v/s portfolio. Change in valuations: When investing in direct equities, volatility in the stock price valuations can be triggered by any announcements/events/performance etc. For example, the recent negative event at Motherson Sumi systems due to the Volkswagen fiasco has led to significant volatility and a fall of approx. 24% in its share price in the last one month, as on Sep 28, 2015. Hence, anyone holding Motherson Sumi stock, would need to take a call on whether to sell it or hold it or buy more, based on his or her conviction and perception. If one who has invested in a mutual fund holding that stock, he or she does not need to take any call as that is the responsibility of the fund manager.Therefore, investment in direct equities requires you to time specific investments based on valuations, which would require regular monitoring of the same. In the case of mutual funds, you do not have to look at valuations. With direct investment in stocks, you not only have to be abreast with the developments in the economy but also keep a close track of the companies in which you have made any investment. Available resources: Compared to the money available for investment with an individual, the investment options seem unlimited. Hence, one needs to be very selective when making investments decisions. For example, consider an individual who has bought shares of stock XYZ at Rs. 100 with the funds available. In case the share price of XYZ drops to Rs. 70 and he wants to buy more of the same stock, he may not be able to do so as his resources may be exhausted or he may have to disturb his overall portfolio to access the funds.In the case of mutual funds, there is a much larger corpus of funds available as it is a pool of funds where multiple investors are investing and dis-investing on a daily basis. So, whenever the fund has a net inflow, the fund can increase its exposure to certain stocks but the flip side is also true, when there is a net outflow, the fund may have to exit some stocks to manage the liquidity requirements.For example, Mr. A and Mr. B both have invested in a fund. However, when Mr. A invested in the fund, the stock price was Rs. 100 and when Mr. B invested in the fund, the stock price was Rs. 70. Hence, in this way, the fund’s average cost becomes Rs. 85 and both Mr. A and Mr. B are benefited as the cost has come down from Rs. 100 to Rs. 85 for Mr. A and Mr. B has a profit of Rs. 15. The above pointers may sound slightly confusing, so we summarize it as below:Direct equities: You should consider investing in direct equities if you have the time to actively monitor and research stocks, you have a reasonable knowledge about the financial markets and you have the patience to bear market volatility. In such cases, it is preferable to invest as lumpsum. Mutual funds: You should consider investing in mutual funds if you do not have the time to actively monitor your investments and cannot bear market volatility. Also, you should invest in mutual funds from a more goal-oriented perspective and we think systematic investment plans (SIP) are the best way to invest in them to create wealth from your income saved over a long period of time.