In December 2007, when the Indian economy was booming, Delhi-based businessman Binod Kumar, 38, wanted to expand his business of kulfi parlours. He wanted to go beyond Delhi to nearby cities such as Chandigarh. After negotiating with a Chandigarh mall, Kumar had a year’s time to set up the new shop. As equity markets were at an all-time high, a friend suggested he invest in equity mutual funds (MFs) for a year and use the returns as capital for his business. Kumar invested Rs4.23 lakh. What followed was unprecedented.
Global markets started to fall, taking Indian equity markets with them. The year eventually turned out to be one of the worst ever for equity markets all over the world. For Kumar, his portfolio of seven MFs was massacred by the end of 2008. He lost Rs2.16 lakh—half of his portfolio.
Everyone makes mistakes. Not just rookie investors such as Kumar, but also seasoned, informed ones. The biggest mistake we make, though, is to throw caution and fundamentals to the wind when the going is good because the value of our equity investments is soaring. It’s only when the markets tumble that we realize our follies, but by then it is too late.
No market instrument, be it stocks or MFs, is immune to volatility. Let’s take a look at some pitfalls and how to avoid these:
‘I wanted quick returns, so I invested in equity funds’
Kumar’s friend suggested he invest in equity funds on the premise that MFs would be safer than going in directly. What he didn’t realize is that even equity MFs invest in equity markets. So when equity markets fall, equity funds suffer too. It could be that they may suffer less than if you had invested directly, because fund managers may be better placed to pick and choose stocks. MFs, however, fall too.
Also, Kumar had invested 35% of his corpus in mid-cap and infrastructure funds, including JM Basic, where he lost 70% of his investments. We recommend: As clichéd as this may sound, if you wish to make money from equity funds, give yourself at least three years. Be flexible and prepared to hold on to them for a longer time if the markets aren’t looking very good after three years. But avoid equity funds if you will need the money within three years.
‘If I buy all best-performing schemes, my returns will be higher’
Nalini Chandrashekar, 28, manages her household finances and investments. Her tryst with investing began as a 17-year-old when she used to help her father arrange share certificates on weekends. By that time, she too started investing in equity shares. Over time, her circle of friends grew to include share brokers who kept giving her tips.
However, she mistook investing in MFs to be the same as investing in stocks. Just as benchmark stock market indices such as the Sensex and the Nifty have 30 and 50 stocks each, Chandrashekar thought a similar number of funds were required to have a well-diversified MF portfolio.
“I had 35 stocks in my portfolio and I thought I needed to have a large number of MFs too to make a decent sum,” she says. Chandrashekar invested in 26 schemes—she eventually sold five, but is still saddled with 21. We recommend: Somehow, the fact that an MF scheme itself invests across 30-60 scrips, or even more, got overlooked. Investing in stocks and MFs is not the same even though both are equity-related. When you invest in an equity share of a company, you are investing in that company’s future prospects.
But when you invest in an MF, you are investing in the capabilities of the fund manager who manages the fund and will then diversify across various stocks and sectors. If you invest in too many schemes with the similar style, you could end up investing in the same scrips through multiple funds.
In an industry whose total corpus size is Rs7,21,886 crore, with at least 800 schemes across categories, you can easily find dozens of well-performing, long-term-oriented schemes. However, for effective diversification, we suggest an MF portfolio of 7-10 schemes.
‘What’s the fund’s net asset value? The lower, the better’
Most new fund offers (NFOs) are launched at Rs10. Some agents and MFs are only too happy to hawk the Rs10 net asset value (NAV) at which these NFOs are initially available, compared with the NAVs of existing funds, some of which may even be in the hundreds. Many investors fall into this trap.
Usha Gupta, a Patna-based businesswoman in her mid-30s, bought almost all the NFOs that hit the market in the past two years. When the equity markets crashed and her portfolio fell dramatically, she realized the value of existing funds that came with a track record.
We recommend: All things equal—there is no difference between a fund with an NAV of Rs10 and another, say, of Rs20. You invest Rs1,000 each in scheme A (a new scheme with an NAV of Rs10) and scheme B (an old scheme with an NAV of Rs20). In other words, you hold 100 units of scheme A and 50 units of scheme B.
Further, assume both schemes have invested their entire corpus in just one stock, which is currently quoting at Rs100. If the stock appreciates 10%, the NAV of the two schemes should also rise 10% to Rs11 and Rs22, respectively. In both cases, the value of your investment increases to Rs1,100—a gain of 10% in both.
The reason why scheme B’s NAV is more than scheme A’s is because it has been around for some time—it has bought and sold since its inception.
In any case, it’s always better to opt for existing and experienced schemes that come with a track record, instead of opting for new funds with no track record.
‘Infrastructure funds are currently hot. I should buy’
A sound MF portfolio is one that is diversified as per your risk profile. But if your portfolio is skewed towards a particular class for no reason, there’s a problem.
Sujoy Mukherjee, a Pune-based IT professional in his mid-30s, invested in the infrastructure funds of almost all fund houses on a friend’s advice. On the back of aggressive advertising of the economy’s prospects in the next five years and benefits that many feel will accrue to the infrastructure sector, Mukherjee bought as many infrastructure funds as he could.
We recommend: You need to have a risk appetite for infrastructure and other such thematic funds because these can be risky on account of their sectoral and scrip concentration. Sectoral funds are most concentrated. These invest in just two-three sectors. In 2008, when the equity markets crashed, infrastructure funds fell by 57%, compared with a 53% fall in diversified funds.
It is good to invest in infrastructure funds selectively. For instance, if you have a small amount to invest, but would like a decent-sized presence in the sector, going through the MF route, albeit an infrastructure fund, would be a better option than investing directly into infra stocks. As a general rule, though, it’s best to have thematic or sectoral funds as a satellite portion of your portfolio. The core allocation of your portfolio should be towards diversified equity funds.
It’s easy to lose sight of plain fundamentals when there is market revelry all around. But, as seen recently, the hangover can be very painful.
• Equity mutual funds (MFs) are risk-free and will do well in any kind of market scenario
• A quick entry and a quick exit is the way to go
• One should have many well-performing funds. The returns will multiply
• The lower the net asset value (NAV), the cheaper and better the fund
• One should quickly buy into a sector which is hot at the moment. For example, the infrastructure sector will do well in the future, so one should get into it in a big way
• All market-related instruments, including MFs, carry a risk. The only advantage that equity MFs have over direct investing is that fund houses are experts in the field
• Have at least a three-year horizon, even more if need be. Avoid equity MFs if your span is less than this
• Keep it simple. Don’t forget that MFs invest in scrips. Too many schemes of the same type may mean duplication of sectors and scrips
• It is the increase and decrease in an NAV that counts, not the NAV itself So whether the NAV is Rs10 or Rs1,000, doesn’t really matter. What matters is how much gain or loss the scheme makes
• Various sectors behave differently. Some are less volatile and give stable, if not high, returns, while others can go up and down a lot. Go by your risk endurance
• Invest in sectors or thematic funds if you understand how they work and what their returns can be. Ideally, these should be peripheral schemes, and not at the core of your portfolio
Know your guidelines
In a bid to keep pace with the changing market structure and bring more clarity in the guidelines for companies issuing shares, the Securities and Exchange Board of India has replaced the Disclosure and Investor Protection Guidelines 2000 with the more relevant and stricter Issue of Capital and Disclosure Requirements Regulations 2009. It has reduced the refund period for the amount, against which shares are not allotted in a fixed price public issue, from 30 to 10 days. The refund period in public issues through the book-building process is also 10 days.
Track your agent
In an effort to rescue “orphan policies”, the Insurance Regulatory and Development Authority has asked insurance companies to enter into agreements with agents for terms of not less than three years. A policy is called an “orphan policy” when a customer can’t track the agent because the latter changed his employer or city. Every insurer has to make adequate arrangements for servicing all policies under outgoing agents. Before the agent leaves, the insurance company needs to ensure that the agent furnishes a list of the serviced policyholders along with their policy and contact details. These details have to be verified by the insurer, confirmed in writing by the outgoing agent and recorded with the insurer. The insurer then needs to allocate these policies to other officials.
Choose your term
If your term deposit with a bank is frozen by an enforcement authority and remains so even after the original term ends, you now have the option of extending the term. The Reserve Bank of India (RBI) has advised banks to give customers the option of choosing the term for renewing the deposit. Earlier, after a frozen term deposit account’s term ended, it could be renewed only till the period equal to the original term. RBI has now said that the depositor should be given an option to choose the term for renewal. If the depositor doesn’t choose a term on his own, banks may renew it for a term equal to the original term.
Soon you won’t have to worry about currency notes getting soiled or soggy. RBI plans to introduce plastic Rs10 notes worth Rs100 crore. The polymer bank notes, with a life cycle four times that of the usual paper currency notes, would be complicated to replicate. A senior official at RBI said: “Plastic notes would last longer. They would be waterproof and, most importantly, they would be very difficult to replicate. Work on plastic notes is still on and details will be announced soon.”
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