Busting common mutual fund myths

Busting common mutual fund myths
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First Published: Sun, Jul 25 2010. 08 05 PM IST

Updated: Sun, Jul 25 2010. 08 05 PM IST
Mutual funds (MFs) are slowly waking up to spread literacy ever since entry loads were abolished, putting more power in the hands of investors. Fund houses such as UTI Asset Management Co. Ltd and the MF industry body, Association of Mutual Funds of India, have hit the highway to come to a town near you to educate you about MFs and financial literacy. While you wait for them to come to your doorstep, let’s begin here, by busting some common myths.
Also See Things to Remember (Graphic)
Myth: A Rs10 net asset value (NAV) fund is cheaper, and therefore, better than Rs50 NAV fund.
Reality: An MF’s NAV doesn’t get influenced by market factors, unlike the price of an equity share. The NAV represents the market value of all its investments. Any capital appreciation that the scheme enjoys or would enjoy depends upon the upward/downward movement of the prices of its underlying securities.
Say, you invest Rs1 lakh each in Scheme A (a new scheme, with an NAV of Rs10) and Scheme B (an old scheme with a NAV of Rs50). In other words, you hold 10,000 units of Scheme A and 2,000 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 by 10%, the NAV of the two schemes should also rise by 10% to Rs11 and Rs55, respectively. In both cases, the value of your investment increases to Rs1.10 lakh—an identical gain of 10%.
The reason why Scheme B’s NAV is higher than Scheme A’s is because the former has been around for quite some time and has been buying scrips before Scheme A was launched. Any subsequent rise and fall in the NAVs of both these funds will depend upon how the scrip moves. Having less units of Scheme B does not make any difference. If anything, you should go for Scheme B as it has a track record and therefore there is some indicator for you to take a reasonable call on its future performance.
“New investors usually get worried about the NAV level; experienced investors may not have this problem”, says Ranjit Dani, a Nagpur-based financial planner and partner with Think Consultants.
Myth: A scheme that pays dividends is better than a scheme that doesn’t.
Reality: MFs are prohibited from assuring any kind of return—principal or dividend. Typically, an MF has a “dividend” and a “growth” plan. While your money keeps going up (or down, whatever the case may be) in the growth plan, your MF occasionally declares dividends in dividend plans. Even monthly income plans (MIPs) aim, but can’t promise, to pay regular dividends. As per data proved by Morningstar India, an MF tracker, MIPs, on average, skipped dividends for two month in each year between 2005 and 2007.
“Dividends in an MF scheme are not like interest earned on bank fixed deposits or non-convertible debentures. The latter are loans that you give to banks and companies for which they pay you interest”, adds Ganti N. Murthy, head-fixed income, Peerless Funds Management Co. Ltd. In other words, a fund that pays dividend is no better or worse than a fund that doesn’t pay dividends.
Myth: Index funds are for wimps.
Reality: Despite having the lowest expense ratio among equity funds and mimicking stock market returns, you will hardly find agents hawking index funds. In reality, passive funds, such as index funds and exchange-traded funds (ETFs), are a potent tool to create and multiply wealth. Benchmark Junior Nifty BeES, India’s only mid-cap-oriented ETF, gave 21.79% returns in the past five-year period against 17.65% category average of mid- and small-cap funds. “When the markets start falling and his fund manager disappears or stops communicating, the retail investor loses confidence. He stops investing. The number of systematic investment plans (SIPs) that stop in falling markets is not funny. If you want an investor to invest continuously, given the potential of India’s economic growth, an index becomes an easy way to explain at all points of a market cycle”, said Krishnamurthy Vijayan, chief executive officer, IDBI Asset Management Ltd, a newly launched MF house that aims to focus only on passive funds in the equity space, in an earlier interview.
Myth: I can do better than the fund manager.
Reality: Like every industry, the MF industry has its share of good and bad fund managers. In the past 10 years, large-cap funds returned 19.21% on average. Despite the worst performing large-cap fund in the past 10-year period returned 7.70%, the top five funds returned 29.11% on average. Most of these funds have been around for more than 10 years and their individual corpuses have grown from Rs500 crore to more than Rs3,000 crore.
While it’s tough to beat the markets consistently—with the kind of corpuses MFs manage—you may avoid the MF route if you think you can navigate the markets on your own. For the rest, we’d suggest the MF bus, preferably through an SIP.
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First Published: Sun, Jul 25 2010. 08 05 PM IST