Mutual Funds -
January 14th, 2008
MUTUAL FUNDS – Along the Horizon of this Decade
By MURTUZA PATRAWALA
Welingkar Institute of Management
What is Mutual Fund?
A mutual fund(MF) is an asset management company (AMC) that pools the savings of a number of retail investors. The money thus collected, is then invested in capital market instruments such as shares, debentures, bonds, short-term money markets and other securities, which is in accordance with the company’s stated objective. Any MF scheme will always have a manager known as Fund manager or Portfolio manager who decides the allocation of resources (where to invest the money) and when to reshuffle the same. A fund manager always has a team and they will go through intense brainstorming, research and analysis before he decides where to invest.
History of MF.
The MF industry in India started in 1963 with the formation of Unit Trust of India, at the initiative of the Government of India and Reserve Bank. The first scheme launched by UTI was Unit Scheme 1964. At the end of 1988 UTI had Rs.6,700 crores of assets under management. In 1987, public sector MFs set up by public sector banks and Life Insurance Corporation of India (LIC) and General Insurance Corporation of India (GIC).
With the entry of private sector funds in 1993, a new era started in the Indian MF industry, giving the Indian investors a wider choice of fund families. Also, 1993 was the year in which the first MF Regulations came into being, under which all MFs, except UTI were to be registered and governed. The industry now functions under the SEBI (MF) Regulations 1996.
With the conforming to the SEBI MF Regulations, and with recent mergers taking place among different private sector funds, the MF industry has entered its current phase of consolidation and growth.
Why is MFs a buzz word today?
Savings form a very important part of the economy of any nation. Investments in various avenues results in the flow of money which in turn acts as the driver for financial growth of the country. The investment objective and risk taking ability vary from person to person. While some might want to save up for their children’s education, others might for life after retirement.
Now, the annual returns on fixed deposits are (approx) 8-10 %, savings schemes give (approx) 4%, PPF gives (approx 8%). The important thing one must bear in mind is the inflation rate while calculating returns which when considered the real returns savings scheme could even be negative. But on the other hand a MF scheme has given returns in the range of 15-30 % depending on the scheme you choose to invest. The 15% returns generated by the MFs are at the relatively lower level of risk. The 30% returns generated by the MFs are at a relatively higher risk but the return potential compensates for the risk attached. This indicates that the MFs cater to the demands of large number of people starting from minimum risk takers to maximum risk takers.
Types of MF schemes.
• Open – ended schemes
• Close – ended schemes
• Growth schemes
• Dividend schemes
• Bonus schemes
• Equity Fund
• Debt Fund
• Balanced Fund
• Money market Fund
• SIP (systematic investment plans)
• STP (systematic transfer plan)
• Tax savings schemes
• Index schemes
• Sector specific schemes
• Equity diversified scheme
MF Industry’s present scenario.
In India as on 1st January 2008, there are 32 MFs with about 6000 schemes and Rs.468000 Crores as AUM (Asset under management). Reliance being the largest MF having AUM of 67500 Crores followed by UTI MF and ICICI Prudential MF. The Indian MF industry is still in its nascent stage when compared with developed markets.
The MF industry has just begun its growth story in the last 4 years where it has grown by 400%. Indian MF industry offers a plethora of schemes and serves broadly all type of investors. The range of products includes equity funds, debt, liquid, gilt and balanced funds. There are also funds meant exclusively for young and old, small and large investors.
How does a MF work?
First and foremost as a MF investor you should know the concept of NAV (Net Asset Value). Net Asset Value is the market value of the assets of the scheme minus its liabilities. The per unit NAV is the net asset value of the scheme divided by the number of units outstanding on the Valuation Date. For example, Fund X has a NAV of Rs 10 and a gentleman invests Rs 1000 then he will get 100 units. And if, say NAV increases to Rs.12 in a year then the gentleman’s investment increases to Rs 1200 (12 x 100) giving him an annual return of 20%. But it is not that simple.
Whenever you buy / sell a MF scheme you have to pay a front-end load and back-end load. These are the fees, which the MF charges from the investors to cover their expenses. For example say that the front-end load is 2%, Fund X has a NAV of Rs 10 and a gentleman invests Rs 1000 then he will get 98 units ( (1000-2%1000) /10)
What do you look for while selecting a MF?
As an investor you need to look at the following things before you decide in which fund to invest.
• First and foremost look for a fund whose investment objectives matches your allocation needs and risk tolerance, because you will find more often than not that the riskier the MF scheme the higher the returns you get.
• Evaluate the past performance of the fund. Most of the funds give you good returns in the first year. Therefore, focus on the performance of the company preferably dating 2 or 3 years back. But remember that past performance is no guarantee for future performance.
• You also need to look at the front-end load and back-end load. Because more the load lesser will be your returns.
• It is also said that you don’t select a scheme but more importantly you select the fund manager. So also look at the Fund manager’s performance and the returns generated by other schemes that are under him.
Advantages of investing in MFs.
There are several advantages on investing in MFs, which are listed below
• Professional management: - As an individual you may not have the time and the expertise to track the market and the company’s performance on a day to day basis, so it is better to leave it to the fund manager who has a full time commitment and expertise. But as an investor you need to track the performance of the fund may be every 3 or 6 months.
• Diversification: - As an individual investor you may only invest in a couple of stocks. But investing in a MF helps you to diversify your investment and reduce risks especially in volatile markets. Even a concentrated fund will be more diversified than an individual’s portfolio.
• Investment through SIP/STP: - As an investor you can also invest in small amounts through SIP, which will take care of the volatility of the market.
• Return Potential: - Investing in a MF scheme gives you a return of 15-30% which is much higher that returns from fixed deposits, savings scheme, PPF, etc.
• Variety of schemes: - Investing in a MF scheme gives you a wide variety of choice to choose from depending on your risk tolerance.
• Liquidity: - Investing in open – ended scheme gives you an opportunity to liquidate your investment at any point of time which is not possible in fixed deposits and savings scheme. (Incase of pre-closure in fixed deposits and savings scheme you will have to pay an additional fee).
Future of MFs.
I have already said that the Indian MF industry is still in its nascent stage when compared with developed markets, for example US has 800 MFs where as India has only 32 MFs at present. If you consider any bull market run in the last century or so you will see that it has at least lasted for a decade, where as Indian bull market run has only begun 3 years ago, leaving huge potential on the upside.
India’s savings and investments are both (approx) 35% of the GDP which are one of the highest in the world. India is one of the youngest countries in the world. Its increasing working population along with the increasing salary will result in increased consumption thereby leading to increased investments in the country.
The biggest hindrance to India growth story is the lack of infrastructure particularly power. Considering the Indo-US nuclear deal goes through and the government’s proliferation in spending on the number of infrastructure projects including mega power projects, this will lead to further investments in the country. Also the government is thinking of allowing the MF industry to invest more overseas which is again positive for the industry. Considering all the above points I here by conclude saying that I am extremely bullish on the MF industry and my belief is that it will go places from here on.