Shyamal Banerjee/Mint
Shyamal Banerjee/Mint

Think twice before buying these funds

Here are a few types of funds that may suit some investors but not all. Do your research before investing

In April 2016, Mint Money had told you about funds that should be there in every portfolio (read it here: http://bit.ly/1RzJ23U). These included liquid funds, diversified funds and equity-linked saving schemes (ELSS). These are some of the basic types of funds available. But there are also funds that you should think about many times before buying. They are not meant for everyone.

Sector, thematic funds

Sector funds, especially information technology linked ones, used to sell like hot cakes around 1999, on the back of the information technology (IT) boom. Schemes that tracked fast-moving consumer goods (FMCG) and pharmaceutical companies were also popular.

When the IT funds failed in 2000 and 2001, fund houses turned towards thematic funds. Between 2005 and 2007 more than 20 infrastructure funds were launched, which collected a total of about 17,105 crore. But most of these haven’t performed well—10 out of a total of 17 have returned 8% or less in the past 8 years. Diversified equity funds have returned 18% in the same period.

“Investors need to understand the risk levels because thematic funds come with high risks, as they focus on just one or few sectors," said A.K. Narayan, a Chennai-based distributor.

Some distributors say that if the investor works in the sector on which the fund is based, then she may invest in these as she would understand the nuances. But many advisers disagree. “The clients may have a good understanding of the sector, but I have a better understanding of their asset allocation and, more importantly, their risk profile and risk appetite," said Sanjay Durgan, founder and director, AbunDanze Wealth Management LLP, a Delhi-based mutual fund advisory. “If they have given us the mandate to manage their money, then I must take the final call on where they should invest," he added.

G-sec funds

Gilt funds invest in government securities (g-sec). The good part is that, due to their sovereign guarantee, they do not suffer from credit risk (the risk that the borrower may not repay). Hence, they are also the most liquid fixed-income instruments. But this is also their undoing. On account of their liquidity—in a debt market that is usually illiquid—g-secs are volatile. In a falling interest rate scenario, gilt funds’ net asset values (NAVs) rise faster than other debt funds’. But when interest rates rise, even marginally, gilt funds fall faster than the rest.

We looked at 3-year rolling returns (with a quarterly frequency) of gilt funds, bond funds and short-term bond funds. These are a series of 3-year returns, taken at the end of every quarter, over a total time period of 10 years. Taking the average of each such scheme’s return for a particular period, we arrived at the average for the category, and maximum and minimum returns.

The maximum return by the gilt fund category was 10.23%. The minimum was 1.37%. Bond funds returned 9.48% on the upside and 4.50% on the downside. Short-term bond funds, 9.29% and 6.46%, respectively. That’s how much variance gilt funds’ returns can have. “Gilt funds are very volatile. Most investors are not willing to hold them for 3 years. It requires an element of timing to capture the returns. These days, investors are buying gilt funds because interest rates are looking to come down, but if rates take a sudden opposite direction, gilt funds can fall sharply," said Deepak Chhabria, chief executive officer and director, Axiom Financial Services Ltd., a Bengaluru-based distributor of financial products.

Gold funds

At one point more money was coming into gold ETFs than was going out. The net inflow in 2010 was 1,727 crore, in 2011 it was 4,046 crore and in 2012 it was 1,826 crore. But tables turned. The net inflow in 2014 was negative 1,651 crore, negative 891 in 2015 and negative 739 till July of this year. The fall has been mostly due to falling gold prices. They were given another blow by sovereign gold bonds.

Budget 2015 proposed the introduction of gold bonds. The first tranche was launched on 5 November 2015. Being government backed, there is safety and assurance of payment. The objective was to develop these bonds as an alternative to buying physical gold (and also allow the government to borrow from resident Indians). These bonds are listed on the stock exchanges and you can buy them from the secondary market.

Gold bonds score over gold ETFs on two counts. First, gold ETFs’ annual expense is up to 2.25%, gold bonds charge nothing. Second, gold ETFs rise in accordance with the underlying price of gold; gold bonds do that too and also pay an interest rate of 2.75% per annum on the amount of initial investment.

“Besides, Budget 2016 made proceeds from gold bonds completely tax free, if you hold them for the entire tenure, which is 8 years," said Amol Joshi, founder, PlanRupee Investment Services. That is why planners and investment advisers like Joshi have drifted away from gold ETFs, and towards sovereign gold bonds.

However, on certain occasions, many advisers still recommend gold ETFs—in addition to gold bonds. Suresh Sadagopan, founder, Ladder7 Financial Advisories, said: “Sovereign gold bonds are good and we do recommend them. But when the tranche comes and if my investors don’t need gold at that time, then I don’t buy. At the time my investors have to invest in gold, and if bonds aren’t available, then I buy gold ETFs."

New fund offers (NFOs)

It is not just a particular class of funds that you need to be wary of. Any type of a new scheme launched should also raise red flags. Although the days when a new NFO hit the mutual fund street every other day are long gone, fund houses still launch new funds. In the years of 2013, 2014 and 2015, 27, 76 and 72 equity-oriented funds were launched and together collected around 14,466 crore. Though amounts mobilised are much lower than the bull years of 2006 and 2007 (43 launched in 2006 that collected 35,037 crore and 64 funds launched in 2007 that collected 38,311 crore), they are still enough to lead astray uninformed investors.

“NFOs are a strict ‘no’ for existing or fresh investors as most of the themes are already covered by existing schemes," said Narayan, adding that he still comes across investors who get swayed by the “10 NAV is cheap" myth.

Of the 25 large-cap oriented new schemes launched recently, and which have completed 1 year, 15 have outperformed the category average and 10 have underperformed. Of the 16 mid-cap funds launched that have completed 2 years, just six have outperformed the category average; 10 underperformed. Although 1-year and 2-year periods are too short to judge an equity fund’s performance, they show that success of NFOs can’t be taken for granted, either.

What should you do?

Not all funds are screaming buys. Some of the funds discussed above may suit some people, but not necessarily everyone. It’s best to consult your financial adviser before you decide to buy.

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