Why choose mutual funds?

Investing in Mutual Funds offers several benefits:
Professional expertise: Fund managers are professionals who track the market on an on-going basis. With their mix of professional qualification and market knowledge, they are better placed than the average investor to understand the markets
Diversification: Since a Mutual Fund scheme invests in number of stocks and/or debentures, the associated risks are greatly reduced.
Relatively less expensive: When compared to direct investments in the capital market, Mutual Funds cost less. This is due to savings in brokerage costs, demat costs, depository costs etc.
Liquidity: Investments in Mutual Funds are completely liquid and can be redeemed at their Net Assets Value-related price on any working day.
Transparency: You will always have access to up-to-date information on the value of your investment in addition to the complete portfolio of investments, the proportion allocated to different assets and the fund manager's investment strategy.
Flexibility: Through features such as Systematic Investment Plans, Systematic Withdrawal Plans and Dividend Investment Plans, you can systematically invest or withdraw funds according to your needs and convenience.
SEBI regulated market: All Mutual Funds are registered with SEBI and function within the provisions and regulations that protect the interests of investors. AMFI is the supervisory body of the Mutual Funds industry.

What are mutual funds?

We have been discussing about mutual funds for long time.

But its time to get strong with fundamentals of mutualfund ,
for better understanding.



Mutual Funds are among the hottest favourites with all types of investors. Investing in mutual funds ranks among one of the preferred ways of creating wealth over the long term. In fact, mutual funds represent the hands-off approach to entering the equity market. There are a wide variety of mutual funds that are viable investment avenues to meet a wide variety of financial goals. This section explains the various aspects of Mutual Funds.

MF NAVs end with negative returns

Equity diversified NAVs continued to remain under pressure and ended lower with negative advance:decline ratio of 4:213 as markets closed deep in the red amid extreme choppiness. Both the benchmark indices --Sensex and Nifty -- slipped below their psychological 9,500 and 2,800 mark respectively. All the sectoral indices closed in the red with realty, banking, metal, capital goods, oil and gas, and power seeing heavy selling pressure.



The Sensex was down 303 points or 3.08% at 9536.33, and the Nifty down 90.20 points or 3.07% at 2848.45.

Among the equity diversified funds, the top gainers were Tata Growing Economies Infrastructure Fund - Plan A (G)
up 2.14%, Franklin Asian Equity Fund (G) up 0.69% and Escorts Growth Plan (G) up 0.39%. The top losers were JM Small & Mid-Cap Fund - Regular Plan (G) down 3.76%, LIC MF Equity Fund (G) down 3.51% and SBI Infrastructure Fund - Series I (G) down .49%.

Among the tax saving funds, the top losers were JM Equity Tax Saver Fund - Series I (G) down 4.05%, JM Tax Gain Fund (G) down 3.38% and Sundaram BNP Paribas Tax Saver (OE) (G) down 3.23%.

Among the sector funds, the top losers were Lotus India Banking Fund - Retail Plan (G) up 3.58%, JM Basic Fund (G) up 3.48% and Sundaram BNP Paribas Select Thematic Energy Opportunities Funds (G) up 3.44%.

Among the balanced funds, the only gainer was Escorts Opportunities Fund (G) up 0.41%. The top losers were Sundaram BNP Paribas Balanced Fund (G) down 2.52%, ING Balanced Portfolio (G) down 2.31% and ICICI Pru Child Care Plan - Gift Plan down 2.14%.

Fund-of-funds: Can it offer tailored investment solutions?

This article discusses fund-of-funds and shows how the structure adds value through manager selection process. It also discusses how such funds can offer better investment solutions and urges asset management firms to offer more such products in the future. 

According to the Web site of the Association of Mutual Funds of India (AMFI), there were 1,043 funds in the country as on September 30, 2008 with assets under management totalling Rs 4,20,862 crore. With 280 equity funds and 471 debt funds, it is small wonder that investors find it difficult to choose appropriate funds to construct an optimal portfolio. 

That is why fund-of-funds becomes a valuable vehicle for investors. 


Paradox of choices 


Fund-of-funds, prima facie, appears a redundant investment vehicle. Such funds after all take exposure to other equity and bond mutual funds — a process that can be easily replicated by investors themselves. The problem is that investors are not as competent as professional money managers at identifying style cycles and manager skill. 

Suppose a person wants to invest Rs 10 lakh today to pay off a certain liability in five years. How should she construct her portfolio of mutual funds? What if she chooses an infrastructure fund when the sector is at its peak? 

Selecting underperforming funds could prove disastrous because the investment will not be able to pay off the liability structure at the horizon. That is why identifying style cycles are important.

Now, take a discerning investor. Suppose she wants some exposure to large-cap value, mid-cap growth, long-term bond fund and a money market fund. As there are many funds available, the investor has to develop some criteria to choose a fund in each category. 

Often, this means choosing the best performing fund in the last one, three and five years. This is not an optimal selection process because no money manager can consistently beat the market.
Manager Selection 


Assume that the market has only 25 professional money managers. If five of them beat the market, it means some others underperform while the rest form the market average. The next year, these five portfolio managers may generate average returns. Later, they may grossly underperform the market. 

Some of the best-performing portfolio managers in the US before 1997 underperformed the Nasdaq during the dotcom era when they failed to ride the technology cycle. 

Selecting portfolio managers who have performed well in the last three years could, hence, be optimal only if their investment style is in vogue in the future as well. 

And that is difficult to forecast. That is why selecting funds that can consistently generate excess returns over the benchmark index (alpha returns) is not so easy. 

A fund of funds structure helps in this regard. The manager of such a fund is expected to have better manager selection skill than an average investor. She also understands style cycles and can, therefore, engage in tactical asset allocation. 

This involves switching from, say, mid-caps to large-caps and from one sector to another to generate excess returns.

The additional layer of cost (MER of 0.75 per cent) that fund-of-funds charge is a compensation for adding value through the manager selection process. 
Offering investment solutions? 



Currently, there are not many fund-of-funds available in the market. Of the ones that are available, some invest only in their own family of funds. Such exposure may not be optimal. The reason is not far too seek.

The best performing mid-cap style, for instance, may be a fund from a competing asset management firm. Taking mid-cap exposure within the family of funds would then be sub-optimal.

But why not use fund-of-funds structure to offer investment solutions to people? This can be achieved using fund-of-funds as a conduit and single asset-class funds as the building blocks. 

Take children’s education fund that some asset management firms offer. Such a fund invests in both equity and bonds and sometimes engages in tactical asset allocation. 

The manager risk is high, as the portfolio manager takes exposure to both asset classes within one fund. Manager risk is the risk that the portfolio manager may underperform her style benchmark.

An optimal alternative would be to offer such exposure through the fund-of-funds structure. Such a fund could take exposure to large-cap index fund, mid-cap active fund and a gilt fund. This reduces manager risk as all managers will not underperform at the same time.

Index funds vs diversified funds - Ways to beat market

The steep decline in the equity market in 2008 has wiped out a large part of investors’ wealth, irrespective of whether they took the direct investment route or went through mutual funds. In a volatile market such as the present one, predicting short-term movements and timing the market, despite the steep corrections already witnessed, remains a challenge. 

In uncertain times investing through index funds may be a better option if one prefers to go with the market tide. The one-year return clocked by the index funds is between -41.5 and - 47.5 per cent, as against BSE Sensex and S&P Nifty decline of 54.7 per cent and 54.3 per cent respectively. 

The divergence between the benchmark performance and the index funds is due to tweaking of the portfolio with minor changes in the weight of stocks held and cash position of the funds. During the same period diversified funds have declined in the range of 34-74 per cent.

Index funds are passively managed funds and mirror the index by holding the index stocks in similar proportions. Being passively managed, index funds have lower expenses than diversified funds. On the other hand, active calls taken by diversified funds can work against them in unpredictable markets in the short-term, resulting in higher declines. 

Diversified fund managers tend to take aggressive or contrarian strategies to outpace their respective benchmarks. Over bullish phases an active fund manager seeks to score a high beta over the benchmark, while also generating consistently superior risk-adjusted returns (called alpha) over the long term. 


Over three- and five-year periods, diversified funds outpaced the index funds by a huge margin. Magnum Contra, an open-ended diversified fund with a good track record, generated a compounded annualised return of 31 per cent over five-year period and outpaced the HDFC Index Fund Sensex Plus Plan by 16 percentage points. However, these funds have outpaced the benchmark BSE Sensex and S& P CNX Nifty over the same time-frame. 

Selecting an index fund requires less effort than choosing a diversified fund. An individual can choose a Sensex or Nifty fund based on his/her risk appetite. However, in diversified funds one has to look out for various aspects such as the fund’s long-term track record, investment style and objectives, along with the fund manager’s ability to produce positive alpha.

RBI aid puts mutual funds on recovery road

     Almost one month after the RBI stepped in to help the mutual fund industry out of its liquidity problems, it does appear that they are on the road to recovery, said mutual fund officials.

RBI had for the first time on October 14 introduced a 14-day liquidity window to provide credit to mutual funds in need. This measure has greatly helped the mutual fund industry, which is now returning to normalcy as redemption pressure has eased considerably and inflows have started to come in, said Mr A.P. Kurian, Chairman, Association of Mutual Funds in India.

The mutual fund industry has borrowed close to Rs 20,000 crore from RBI, out of which about Rs 9,000 crore has been paid back, said Mr Kurian.

While the borrowing was much less than the limits provided by RBI, the announcement of the measures was made at the most appropriate time. Else there was a possibility of three or four fund houses going bankrupt, said Mr U.K. Sinha, Chairman & Managing Director, UTI Asset Management Company.

The first liquidity measure, which was introduced on October 14, just four days ahead of the monetary policy, came as a complete surprise as far as its timing was concerned.
Woes of industry 



The problem of the mutual fund industry was a mix of liquidity crunch and credit aversion. While the liquidity issues have been dealt with, the credit aversion is easing off slowly, said Mr Ramkumar K., Head-Fixed Income, Sundaram BNP Paribas Mutual.

In October, redemption requests from corporates were unusually high because of the lack of confidence and the liquidity crunch, said Mr Sinha. With the money market having dried up and banks not trusting each other, corporates felt it safer to withdraw their cash from mutual funds and park it with themselves, Mr Sinha said.

In October, no institutions, including banks, were willing to buy any papers (CDs or CPs), said Mr Badrish Kulhalli, Senior Fund Manager-Debt, Principal Pnb Asset Management Company.

While banks were not willing to lend, RBI indicated to the banks and corporates that the Government would lend support to the mutual fund industry, which helped improve the scenario, said the mangers.

The response to RBI measure was lukewarm in the first phase. Continuous dialogue and easing off of higher interest rates helped improve the issue. While banks had agreed to lend to mutual funds, the cost of borrowing was high for the funds, who in most cases do not make much money on their liquid schemes, said Mr Waqar Naqvi, CEO of Taurus Mutual Fund.

RBI’s relief measures have helped the industry considerably, to the extent that earlier while CDs were being borrowed at interest rates as high as 13-14 per cent, they are now at 10 per cent, said Mr Ramkumar.

It would have helped mutual funds better if the tenure for the liquidity window was flexible as some mutual funds were reluctant to borrow on a 14-day lock-in period and would have preferred a lesser time span, said the head of a mutual fund house.

However, the problem will be permanently addressed only when the mutual funds’ sources of funds, namely the corporate houses and investors, start investing in the usual way, said Mr Naqvi.