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10 myths about Systematic Investment Plans

Although SIP is a popular investment method for most, there are still several myths surrounding SIPs. PV Subramanyam tries to break 10 myths about SIPs and bring more clarity to this concept of investing.


What is a Systematic Investment Plan (SIP)?

SIP is a method of investing a fixed sum, regularly, in a mutual fund. It is very similar to regular saving schemes like a recurring deposit.

An SIP allows you to buy units on a given date each month, so that you can implement an investment / saving plan for yourself. Once you have decided on the amount you want to invest every month and the mutual fund scheme in which you want to invest, you can either give post-dated cheques or ECS instruction, and the investment will be made regularly. SIPs generally start at minimum amounts of Rs 1,000 per month and the upper limit for using an ECS is Rs 25000 per instruction. Therefore, if you wish to invest Rs 100,000 per month, you may need to do it on 4 different dates.

As is customary, I started with describing the concept of an SIP. Let us break some myths on SIP now.

Investment in equity mutual funds or unit linked insurance should always be done in SIP mode: I remember in 1999 when Templeton Mutual fund would talk about SIP – the market looked at it skeptically. And it took a lot of convincing for customers to accept it. Now, life has come a full circle. Everybody wants to (always) invest using an SIP. If you have the maturity and calmness to realize that equities are for the long term and are willing to give your funds about 10 years, and you have a lump sum, you can afford to give the SIP route a pass. However, if your horizon is less than five years, you must do an SIP.

I do rupee cost averaging in a single equity – that is a kind of SIP is it not? This is a question I face every day. No, a rupee cost averaging in a single scrip cannot be equated to an SIP. When the market brings down the price of a single scrip, it is giving you information. You need to react to that.

Let us take 2 examples – Lupin Laboratories – has moved from a high of Rs 700 to Rs 100 and back to Rs 700. The question to ask here is not whether an SIP would have worked. The question to ask is whether you would have had the stomach to continue the SIP through this period. Silverline Technologies moved from Rs 30 to Rs 1300 to Rs 7! In this case, if you had started an SIP at a price of Rs 1300, today you would be licking your wounds. SIP works in a portfolio, not in a single scrip.

You cannot invest a lump sum in the same account in which you are doing an SIP: Many people assume that if they are doing an SIP in a particular fund, and suddenly they have a surplus, they cannot put that lump sum in that account. Fact is, in case you are doing an SIP of Rs 10,000 per month in an equity fund, and suddenly you have a surplus of Rs 100,000 and clearly you have a 10-year view on the same, then you can just push it into your SIP account. SIP is just a payment mode, not a scheme!

If I miss investing for a particular month, will they prosecute me? Now, this is the fear of EMI that people have. In an SIP you are buying an investment every month (or quarter), there is no question of prosecuting you for missing one investment. As a matter of discipline, you should not miss any month; however, missing one month’s investment is not a crime!

When you have a surplus (accumulation stage of your life) you should do an SIP and during retirement you should do a SWP: No. You should ideally keep your withdrawals only from an income fund or a bank fixed deposit. You should sell an equity fund on some other basis, say deciding to sell 20% of your portfolio in a year so that the return is 4 times the 30 year historic return. SWP, by definition cannot work in an equity fund!

SIP works for everybody, but does not work for me: Another myth. SIP works in a well-diversified equity fund in the long run. When people put forth arguments that it does not work for them, they have either not chosen a good fund or are looking at a 12 month horizon.

SIP is only for small investors: Nothing can be farther from the truth. I have a client who has invested Rs 32.66 lakhs using SIP, starting from January 1998 till date. Obviously, he has invested much more in later years as his income went up and the funds together are worth Rs 97 lakhs, substantially higher than his provident fund.

Market is at very high level to start an SIP: I have heard this when the index was 3000 also. I have no clue where the market is headed, but I know SIP works!

All fund houses are now charging a full load on the SIP, so now SIP will not work Why not time the market? Introducing an entry load was expected to happen and it has happened. What actually hurts the retail investor is the asset management charges – 2.5% in most cases is a bigger threat to compounding!

If I do an SIP in a tax plan, can I withdraw all the money on completion of 3 years? Another regular question almost! Every installment has to be with the fund house for 3 years. The lock-in comes from the Income tax rules, which say that a tax saving scheme should have a 3-year lock-in. You cannot escape that by doing an SIP!

The author, PV Subramanyam, is a financial domain trainer. He can be reached at .

7 good reasons to invest in SIPs

Fact No. 1: Over a long term horizon, equity investments have given returns which far exceed those from the debt based instruments. They are probably the only investment option, which can build large wealth. Fact No. 2: In short term, equities exhibit very sharp volatilities, which many of us find difficult to stomach. Fact No. 3: Equities carry lot of risk even to the extent of loosing ones entire corpus. Fact No. 4: Investment in equities require one to be in constant touch with the market. Fact No. 5: Equity investment requires a lot of research. Fact No. 6: Buying good scrips require one to invest fairly large amounts.

Systematic Investing in a Mutual Fund is the answer to preventing the pitfalls of equity investment and still enjoying the high returns. And it makes all the more sense today when the stock markets are booming.

1. It’s an expert’s field – Let’s leave it to them
Management of the fund by the professionals or experts is one of the key advantages of investing through a mutual fund. They regularly carry out extensive research - on the company, the industry and the economy – thus ensuring informed investment. Secondly, they regularly track the market. Thus for many of us who do not have the desired expertise and are too busy with our vocation to devote sufficient time and effort to investing in equity, mutual funds offer an attractive alternative.

2. Putting eggs in different baskets
Another advantage of investing through mutual funds is that even with small amounts we are able to enjoy the benefits of diversification. Huge amounts would be required for an individual to achieve the desired diversification, which would not be possible for many of us. Diversification reduces the overall impact on the returns from a portfolio, on account of a loss in a particular company/sector.

3. It’s all transparent & well regulated
The Mutual Fund industry is well regulated both by SEBI and AMFI. They have, over the years, introduced regulations, which ensure smooth and transparent functioning of the mutual funds industry. This makes it safer and convenient for investors to invest through the mutual funds.

4. Market timing becomes irrelevant
One of the biggest difficulties in equity investing is WHEN to invest, apart from the other big question WHERE to invest. While, investing in a mutual fund solves the issue of ‘where’ to invest, SIP helps us to overcome the problem of ‘when’. SIP is a disciplined investing irrespective of the state of the market. It thus makes the market timing totally irrelevant. And today when the markets are high, it may not be prudent to commit large sums at one go. With the next 2-3 years looking good from Indian Economy point of view, one can expect handsome returns thru’ regular investing.

5. Does not strain our day-to-day finances
Mutual Funds allow us to invest very small amounts (Rs 500 – Rs 1000) in SIP, as against larger one-time investment required, if we were to buy directly from the market. This makes investing easier as it does not strain our monthly finances. It, therefore, becomes an ideal investment option for a small-time investor, who would otherwise not be able to enjoy the benefits of investing in the equity market.

6. Reduces the average cost
In SIP we are investing a fixed amount regularly. Therefore, we end up buying more number of units when the markets are down and NAV is low and less number of units when the markets are up and the NAV is high. This is called rupee-cost averaging. Generally, we would stay away from buying when the markets are down. We generally tend to invest when the markets are rising. SIP works as a good discipline as it forces us to buy even when the markets are low, which actually is the best time to buy.

7. Helps to fulfill our dreams
The investments we make are ultimately for some objectives such as to buy a house, children’s education, marriage etc. And many of them require a huge one-time investment. As it would usually not be possible raise such large amounts at short notice, we need to build the corpus over a longer period of time, through small but regular investments. This is what SIP is all about. Small investments, over a period of time, result in large wealth and help fulfill our dreams & aspirations.

The author is Sanjay Matai, Investment Adviser. He can be reached at .

Future is costly; Invest now to beat inflation


It is no longer sufficient to 'save', the need of the day is to 'invest'. Sandesh Kirkire tells you why, where and how to invest.

The concept of savings and investments has noticeably changed over the years. The time has come when every individual and prospective investor should realize the significance of these two words and learn to differentiate between them.

Evolution of Lifestyle and our Savings
Today it is essential to look into our lives and analyze our needs for the present and the future. The situation has changed from the period of our parents and grandparents when they considered their savings would suffice through their lifetime. Though the core ideas behind savings have remained much the same such as emergency needs and social needs, there has been the introduction of aspiration needs as well. The fact that aspirations have become realizable has furthered this need.
This is evident from the fact that the average age for house owners was 42 years in late nineties as compared to about 34 years now.
The aspirations of flying abroad for holidays, maintaining a certain lifestyle, quality education for children and various personal goals have come

The consumer revolution and the easy availability of loans for almost every purpose have increased the household liabilities many fold. Infact, the average retail liabilities of the country have jumped to above Rs 2 lakh cr .

The result of this change has been an increased need of money, which at times becomes difficult to be met by simply saving. The savings philosophy too seems to have changed. Earlier savings preceded expenditure while it is now vice-versa. Simple forms of savings in the form of deposits or administered savings are no longer sufficient to meet the ever-increasing requirements of the household. Thus the time has come to save intelligently through the various avenues of investment.

It is essential to note that it is no longer sufficient to “save”- the need of the day is to “invest”.

India’s domestic savings as a percentage of our GDP is 28%, which is one of the highest in the world. A significant proportion of this savings is in the forms of fixed deposits that fetch an interest below the rate of inflation and are further reduced after taxes. This reflects that we are loosing a significant proportion of our savings by allowing inflation to eat into it.

The time has come for us to look at investment avenues, which can beat inflation and help our money to grow further in order to meet our future requirements. Investments in various forms will enable us to meet inflation and protect our purchasing power along with aiding us to generate a sustained income post retirement.

Not investing in Equity could mean a higher risk
Investments can be regarded as secondary source of income where we allow our money to grow for the future. One of the available investment avenues is equity related investment, where currently only 2-3% of household savings are invested.
One of the reasons why there is an under ownership of Indian households into Equity asset class is the availability of assured return investment options. Now with the structural decline in interest rates, the returns are likely to be largely commensurate with the underlying risk. The high return – low risk syndrome will have little place in the fast changing investment landscape in India.

Indian investors have been traditionally risk-averse. They need to appreciate that buying into an equity share is buying a part ownership of the company. As there is the case with any business, the gestation period would be longer, say 2-3 years or so. There could be volatility in the intermediate period; however, the returns are worth the wait and the intermittent risk.

By not investing in equity investors feel that they are a ing risk but they may be taking a greater risk since their investments will be unable to cope with inflation and tax.

The figure below clearly highlights that on 20 years CAGR equity as an avenue of investment has outperformed inflation and other significant investment avenues. Ask yourself, “Have your savings grown post tax, post inflation?”

It has been statistically proven in many markets, including ours, that over time, equity outperform most asset classes. It helps to think of risk as an opportunity. "Nothing ventured, nothing gained" applies just as much to the stock market as to other aspects of life.

The markets have become very volatile and are dominated by wholesale investors. Such wholesale investors do extensive research on all the companies that they invest in. The markets today discount the forward performance in advance and the stock prices merely adjust depending upon the quarterly performance. It, therefore, becomes very difficult for a lay investor to track corporate performance on a continuous basis. It is here that the mutual funds offer adequate diversifications.

Mutual Funds - A proven investment vehicle
Mutual Funds, a pool of like-minded people, allow investors to reap the benefits of a diversified, well researched and an actively managed portfolio, without having to worry about liquidity.

In several developed countries, the mutual fund industry is a bigger financial intermediary than even the commercial banks. For example, in the US, the assets under management are larger than the aggregate bank deposits. The relative size just goes to prove the role of mutual funds in wealth creation for investors at large.

In India too we anticipate a higher allocation of household financial savings in securities market, through the professional managers.

The power of active funds management
Consider the performance of mutual funds over the last 10 years, as on 11-08-05. The average returns of top 5 diversified equity mutual fund schemes is 24.69% CAGR, whereas the BSE Sensex has grown by only 8.66% CAGR. It implies that Rs 100,000 invested in Mutual Funds 10 years back would have grown to Rs. 9.08 lacs, whereas the same amount invested in BSE Sensex companies would have grown to only Rs. 2.29 lacs. This is the power of active management of your assets.

Systematic Investment Plan - An Effective Solution
The secret of wealth creation through investments lies in disciplined investments and not in being lucky. The performance of equities is affected by the volatility in the market. Market sentiments act as a driver for equity investments pegging them down or pulling them up at times. The mutual fund industry provides a solution to all these aspects in the form of Systematic investment Plan.

The idea of Systematic Investment Plan comprises of providing fixed amounts of investments at regular intervals and in the same scheme. In terms of pattern, it is comparable to paying monthly installments in the form of EMI’s for asset-finance. SIP can be used as an ideal investment avenue to meet the increasing load of liability that has entered the life of Indian consumers today.
SIP helps to make the volatility in the market work in favor of the investor.
If the same amount is invested at regular intervals of time, the purchase cost will be averaged out.

When the NAV of the scheme is increasing, the average cost of purchase of units will be less in the case of an SIP. In the very opposite situation where the NAV is falling, investments in an SIP will allow the investor to buy more units in the scheme.

One of the most significant benefits of SIP investment is the advantage of compounding about which Benjamin Franklin had once said “ Compound interest is the eighth wonder of the world”.
Finally another advantage of SIP is the available convenience with which an investor can invest in the available schemes. The amount of savings to be invested monthly can be decided at the convenience of the investor.

Early investing has it’s own advantage. Consider the following example…

Suppose you start investing in a diversified equtiy MF through SIP at age
35 (Age)
40 (Age)
Your monthly investment
Rs 5000
Rs 5000 respectively
You stop investing at age
60
60 respectively
Your total contribution
Rs 15,00,000
Rs 12,00,000 respectively


Assuming CAGR from the fund of 15%, your savings could grow to
Rs 1,37,82,803.88
Rs 66,35,367.20


It is evident in the present economic circumstances that inflation is a reality and has to be tackled. Mutual Funds and specially Systematic Investment Plan may be an ideal mix for an investor to overcome inflationary consequences and further create wealth.

The author is Sandesh Kirkire, CEO, Kotak Mahindra AMC.

Cutting through the MF jargon to pick the right fund

To benefit from equity funds, one should select them carefully and have them in the right proportion in the portfolio. Here is a good guide to pick the right one for your needs.

Over the 41 years that have passed since the first mutual fund was launched in India, the mutual fund industry has adapted and expanded its product line to suit just about every requirement of investors in different segments. The continuing innovations in the variety of products offered to investors encouraged them to take a look at the diverse menu and sample the products.

However, many a times, the booming stock market and the variety of equity products prompt investors to invest in anything and everything that comes their way. As a result, they develop a portfolio that consists of schemes that either do not match their investment objectives or risk profile. To benefit from equity funds, there is a need to select them carefully and have them in the right proportion in the portfolio.

Let us analyze different types of equity funds and examine how they are different from each other and what do they offer. A better understanding of these products helps investors in having them in the right proportion in the portfolio.

Diversified Funds:

A diversified fund is a fund that contains a wide array of securities. The fund manager of a diversified fund actively maintains a high level of diversification in its holdings, thereby reducing the amount of risk in the fund. In other words, the fund manager designs the portfolio in a manner that it is not dominated by companies from one industry or a particular segment.

In a typical diversified fund, the offer document provides freedom to the fund manager to invest across industries as well as various market segments i.e. large cap, mid cap and small cap. However, most fund houses have internal guidelines for fund mangers with regard to the maximum exposure they can have in each industry as well as segment.

Flexicap / Multicap Funds:

These are by definition, diversified funds. The only difference is that unlike a diversified fund, the offer document of a multi cap / flexi cap fund generally spells out the limits for minimum and maximum exposure to different market caps. To that extent, an investor retains the control on the exposure to each market segment, which is not possible in a typical diversified fund. However, thanks to the flexibility available to the fund manager in a diversified fund, he can handle the volatility in a much better manner.

Index Funds:

An index fund is a type of passively managed fund that seeks to track the performance of a benchmark market index like BSE Sensex or S&P CNX Nifty. In other words, the fund maintains the portfolio of all the securities in the same proportion as in the benchmark index. The offer document of an index fund clearly states as to which index the fund would track.

The major advantage of investing in an index fund is that one knows exactly the shares the fund would invest in. Besides, for an individual investor, it is practically impossible to create a portfolio that matches an index fund portfolio. The downside of investing in an index fund is that one forfeits the possibilities of earning above average returns that a good quality diversified fund may be able to provide over the longer term.

Index funds differ from an actively managed diversified fund in that trading is done not in an effort to sell non-performing securities and buy the better performing ones but to mimic a changing index and to deal with fresh inflows and outflows on account of redemption.

Dividend Yield Funds:

A dividend yield fund invests in shares of companies having high dividend yield. Dividend yield is defined as dividend per share divided by the share’s market price. Most of these funds invest in the stocks where the dividend yield is higher than the dividend yield of a particular index i.e. Sensex or Nifty.

It is also worth mentioning here that the prices of dividend yield stocks are less volatile than the growth stocks. Besides, they also offer the potential to earn appreciation.

Within the diversified equity funds space, dividend yield funds are considered to be the medium risk proposition and are ideal for investors who are looking to diversify within equity segment and require regular dividends. It will not be wrong to say that dividend yield funds are more conservative and less risky cousins of diversified funds. However, it is important to note that dividend yield funds have not always proved resilient to short-term corrective phases.

Contra Funds:

A contra fund is actually a contrarian fund that invests in out-of-favour companies but at the same time have unrecognized value. The reasoning behind this approach is the belief that sooner or later other investors will realize the true value of these companies and buy their shares, thereby increasing the stock prices.

These funds are ideally suited for investors who want to invest in a fund that has the potential to perform in all types of market environments as it blends together for both growth and value opportunities.

Opportunity Funds:

While opportunity funds are by definition diversified, they are aggressive by nature. In fact, they generally aim to perform better than diversified funds. In other words, the emphasis of an opportunity fund is on generating superior returns rather than risk containment. The downside of an opportunity fund is that there is a risk of the fund manager’s style becoming individualistic. There is also a danger of having over-exposure in a particular sector thereby increasing the risk. The key, therefore, is to keep an eye on the portfolio composition on a regular basis. The exposure to opportunity funds should generally be limited to around 10-15% of the portfolio.

Mid-cap Funds:

Mid-cap funds invest in mid-cap stocks, as they are called- short for middle capitalization. Each of these funds generally have their own definition of mid-cap stocks. Mid-cap funds are a good means to enhance returns and add a flavour of growth to the portfolio. Investors with some appetite for risk should consider adding mid-cap funds to their existing mutual fund portfolio. 'Existing' is the operative word over here. It means that investors must have a portfolio to begin with, preferably with large cap diversified equity funds forming a substantial chunk.

Sector Funds:

These funds are highly focused in that their investments are aimed at a particular industry. The basic idea is to enable the investors to take advantage of industry cycles. Since these funds ride on market cycles, they have the potential to offer good returns if the timing is perfect.

However, sector funds should constitute only a limited portion of a portfolio, as they are much riskier than a diversified fund. As these funds invest in one industry or sector, they do not provide the downside risk protection available in a diversified fund.

Exchange Traded Funds:

An Exchange Traded Fund (ETF) is a fund that combines the features of an index fund as well as stocks. These funds are listed on the stock exchanges and their prices are linked to the underlying index. The authorised participants act as market makers for ETF’s.

ETF can be bought and sold like any other stock on an exchange at prices that are expected to be closer to the NAV at the end of the day. Therefore, one can invest at real time prices as against the end of the day prices as is the case in open-ended schemes. Besides, there is no paper work involved for investing in an ETF as these can be bought like any other stock by just placing an order with a broker.

As we all know, to earn higher returns one has to take higher risks. The average extra return that one can expect to receive is dictated by the market forces on which one has no control. It is, therefore, necessary to have the right mix of equity funds in the portfolio and have a long-term view. Besides, one needs to keep a watch on the portfolio composition i.e. whether the fund has a concentrated portfolio or has unproductive diversification. While a concentrated portfolio makes the fund risky, a portfolio overloaded with minuscule investments in a wide array of stocks makes the portfolio unhealthy.

The author is Hemant Rustagi, CEO, Wiseinvest Advisors Pvt. Ltd. He can be reached at

Sector, theme funds are not for everyone

Focused Funds (sector funds or theme funds) are meant for investors who are financially well educated, and/ or have some specialized knowledge.

What are Sector Funds?

Sector funds focus on companies, which are all in the same or similar line of business – such as technology or textiles or tanneries. Such funds are meant for people who have a clear view on a specific business. Let’s say you have immense knowledge about Textiles, but don’t have enough money to diversify across the best players in the industry, a Textile-sector fund is for you. Remember, however, that a Textile-sector fund does not have a mandate to invest in Technology, for instance. So your money sinks or swims (or flies high) with the Textile-sector.

Sector funds are not for everyone

People associated with a particular sector who believe that their industry is going to do very well and have a clear time horizon for it; analysts who track specific sectors; professionals working in a sector; Fund of funds or Private Wealth Managers for their HNI clients. Anyone who is investing in a sector, based on romantic dreams surrounding the current favourite, should think twice. In investment, romance is a bad reason for long-term commitment.

Theme funds are a little different

They are usually diversified across sectors. The difference between it and a diversified fund is that the former is supposed to invest based on a particular dominant “prime-mover of profitability”.

Thus “outsourcing” is a theme: IT companies make money from it, so do medical companies, so do automobile ancillary companies and even textile companies. While a Textile Sector Fund would invest only in the Textile sector, an Outsourcing Theme Fund could invest in any of the above-mentioned industries or all of them. Some of the themes underlying the current economic resurgence of India are outsourcing, services (as opposed to manufacturing), infrastructure, debt restructuring, mergers & acquisitions etc.

One may wonder why a fund manager cannot take advantage of these themes in any diversified equity fund. Well, Fund managers do study themes while picking stocks. A fund manager of a diversified fund, however, takes advantage of various themes to generate returns, while a Theme fund follows only one.

An investor who is convinced that it is one main theme, which is going to be the dominant reason for businesses to succeed, can pick a theme fund. If for instance you believe that at 6700 the index is over its main bull phase and the only stocks that are going to give super-normal returns are those who either merge with a larger player or acquire a smaller one, thus driving towards oligopoly – well an M&A-theme fund is for you.

As you can guess, theme funds are for specialists too, who with their expertise have spotted some trend and want to create a diversified basket (mutual fund) to take advantage of this trend.

A word of caution

A word here about fund-names and their underlying themes: many funds use catchy names for marketing reasons, but a study of their Offer Document (Check “Investment Objectives”) will tell you that they are vanilla diversified funds: the name just reflects marketing creativity and not funds management conviction!

What do you do if your focused fund has turned out to be a laggard?

My own advice is to talk to a good ARMFA and cut your losses. You can set these losses off against appropriate capital gains; you can invest in diversified funds and over time re-coup your losses; you can use the money to pick up another asset; anything other than just locking up the account statement and pretending it never happened. That is the worst thing to do with a bad investment.

Of course, let us assume you still believe very strongly in the sector or theme. If you believe in the fund manager, average your cost down by investing more in the same fund. Else, pick another fund manager in the same sector who is doing better and move from the old fund to the new one (keep track of your losses for future set off).

In a nut shell, therefore my advice is:

• For a savvy investor, with specific knowledge about a sector, sector funds are a great investment option; for others it is not advisable.
• The same applies to narrow theme funds.
• Theme funds, if adequately diversified are good for the lay investor, but the decision should be based on your trusted ARMFA’s view about the fund, the fund manager and the house.
• Preferably pick a diversified fund, unless you know what you are doing.
• If you are stuck with a bad investment exit, and use the money as well as the loss.
• If you are stuck with a good theme or sector which is currently doing badly average down or change funds.

HAPPY INVESTING.

The author is Krishnamurthy Vijayan, CEO, JM Mutual Fund.

Don’t just look at ‘Returns’, look at quality too

Here is a simplified guide to help you understand how to assess the quality of your Mutual Fund in a few easy steps.

The mutual fund industry is on the roll, managing around 250 pure equity oriented schemes. And with the many New Fund Offers, this number is steadily going up.

This vast universe of schemes is making it difficult for the investors to select the ‘good’ funds to invest in. The easiest way, of course, is to choose the best performing funds in terms of ‘returns’. One could look at say 1-yr to 3-yr performance of the funds and choose those, which have yielded maximum returns.

Yes, the returns are important but it is also important to look at the ‘quality’ of the returns. ‘Quality’ determines how much risk a fund is taking to generate those returns.

Equity investing is a risky business and it is important that a fund should be managing risks effectively. This is especially true now when the market has run-up quite sharply and the valuations are stretched. In the event of a sharp correction, it is the quality funds, which will usually fall less and also rise up faster when the up-turn begins.

One can make a judgment on the quality of a fund from various ratios such as Standard Deviation, Sharpe Ratio, Beta, Treynor Ratio, R-Squared, Alpha etc. The names may look intimidating, but are not so difficult to understand. Moreover we will not be looking at how to calculate these numbers (the process is quite cumbersome and these are easily available on websites/magazines), but what they represent and how one should interpret them.

Standard Deviation

Standard deviation, one of the commonly used statistical number to measure risk, determines the volatility of a fund.

Since the markets are volatile, the returns fluctuate every day. Therefore, we usually calculate an average of the returns over a period of time say daily returns or monthly returns. But this average can sometimes be misleading.

For example, the average of 5 numbers – 2,4,3,6 & 5 – is 4. Similarly the average of 4,4,4,4 & 4 is also 4. But the first series is more volatile than the second.

This is where Standard Deviation helps in analyzing the ‘quality’ of the average. It tells us how much the individual numbers deviate from the average. Or in other words how closely the average represents the underlying numbers.

Higher the Standard Deviation of a fund, means the fund is more volatile and its’ returns are likely to fluctuate more. In a single number it captures the swing in the fund’s past performance and helps in estimating future returns.

Suppose a fund gave an average return of 12% per month last year and the standard deviation was 5. Then, statistically, one can say with 68% probability that the return will be within 7% to 17% (i.e. 12-5 to 12+5). And 95% of the times the return will be within 2% to 22% (i.e. 12-2*5 to 12+2*5).

Thus by investing in a fund with lower standard deviation one can expect to reduce the uncertainty of returns. It doesn’t mean that one will not lose money; only the probability is lower. Also, only looking at lower standard deviation is not sufficient. A fund may have lower standard deviation but still be a poor performer as far as returns are concerned.

Sharpe Ratio

Sharpe Ratio = (Avg return – Risk free return)/Std. Deviation.

In simple terms, Sharpe Ratio is a risk to reward ratio, which helps in comparing the reward (or the return) given by a fund with the risk that the fund has taken i.e., it calculates the risk-adjusted return.

The whole idea of taking risk is to make more money than what is offered by assured and 100% safe instruments. Thus the ‘net return’ – i.e. actual return minus the risk free return (i.e. say returns from 100% safe options like PPF or NSC or Govt.Sec etc.) - is used in the formula.

The risk that the fund has taken is known from its’ standard deviation.

Sharpe ratio of a fund, by itself, does not convey much meaning. It has to be compared with the other funds. Two funds may have given same returns. But a fund with a higher sharpe ratio means that these returns have been generated taking lesser risk. In other words, the fund is less volatile and yet generating good returns. Thus, given similar returns, the fund with a higher sharpe ratio offers a better bet for investing.

It may, however, be clarified that life is not so simple. Just because a fund has higher sharpe ratio does not mean that it will perform better in the future. But yes the probability is higher. Moreover, Sharpe ratio does not tell us things like portfolio risk. The Sharpe ratio may be favourable, but the fund may be heavily invested in a particular sector. Therefore, such fund is open to sector risk.

Beta

Beta captures the market risk. It tells us about the sensitivity of a fund to the market. It is a relative risk measurement number, which gives an indication of how a particular fund is expected to move with the movement in the market or a benchmark index. It is different from Standard Deviation, which measures how volatile the fund is by itself.

By definition, the beta for index/market is 1. A particular fund can have beta of less than 1, 1 or more than 1.

Suppose a fund has a beta of 1.25. And the market/index is expected to move up/down by 20%. Then, the fund will most likely appreciate/depreciate by 25% (i.e. 1.25*20%). Or say a fund has beta of 0.9. Then with a market movement of 20%, it will move by 18% (0.9*20%).

Thus, if the beta for a fund is less than 1, then it is less volatile than the market movements. And if beta is more than 1, then that fund is more volatile than the index.

Therefore, choosing a fund with lower beta means a less riskier proposition, but the expected returns can also be lower vis-à-vis a high beta (and hence riskier) fund.

It is, however, important that the comparison of a fund beta should be done with a relevant index. For example, it will not be correct to compare the beta of a mid-cap fund with the Sensex. To know whether a fund can be reliably benchmarked against a given index, ‘R-squared’ is used. R-squared varies between 0 (meaning no co-relation) and 1 (meaning perfect co-relation). Generally an index and fund can be taken as co-related if R-squared is 0.75-0.80 or more.

Risk analysis is an important aspect of fund selection. But it may be kept in mind that no single risk measure can predict the fund’s volatility with 100% accuracy and no single number is sufficient to make a judgement about the fund quality. Various factors – past performance, risk analysis, portfolio characteristics, management style, fund house etc. - have to be simultaneously considered.

The author is Sanjay Matai, Investment Adviser.

Is Risk eating into your portfolio?

Too much or too little Risk might jeopardize your financial future. Amar Pandit tells you how to strike the right balance.

Recently I saw a poster of a movie named “Gafla”…The tag line of this movie read, “ The biggest risk in life is not taking one”. According to me “The biggest risk in life is taking one but believing you have not taken any” or “taking one but not understanding the consequences of your decision”.

Too often we focus on the wrong set of parameters such as oil prices, stock prices, interest rates when it comes to making equity investments. People spend countless hours watching Business channels, reading magazines for hot tips, tracking the unknowns but there is hardly any time spent on the knowns, which is solely in your control.

I have shared some of the UNKNOWNS that we so often focus on and the KNOWNS that we ignore most of the time.

UNKNOWNS (This is NOT in anyone’s control)[LIST][*]Sensex and Nifty Behavior [*]Stock Prices [*]Oil Prices [*]Interest Rates [*]Inflation [*]Tax Laws & Regulations [*]Geo Political Risks
[/LIST]
KNOWNS (This surely is in your control)

• My Needs and Goals
• What is my time horizon?
• What is it I want to achieve in Life?
• How do I react to different things including Stock Market Ups and Downs?

In fact when it comes to investing, to be a winner, one must make as fewer costly mistakes as possible. A lot of people like to believe that they are better-blessed souls of our century who do not make mistakes. There is no one in the world of investing who has not made a mistake. The key point is to understand how to a costly mistakes. Getting back to my point, Understanding and Managing Risks are the most important parts of the investing process. Take too much Risk and you might jeopardize your financial future with huge losses. Take too little and you jeopardize your financial future with low returns barely enough to cover your lifestyle expenses.

So how do you determine how much risks you should take and are you taking enough?

First determine what returns you reasonably need to achieve your financial goals (Assuming that you know what your goals are). So if you need a 10 % return, why should you opt for some exotic thing like a derivative or trade like a maniac! I met a person recently who tracks the market day in and day out, devours every investment magazine and finally when the stock market closes, switches to the commodity market. Guess how well his portfolio is doing. From a value of Rs. 4 Crore it has come down to 2.8 Crore most of which I would attribute to a pinch of foolishness (with due respect) and a dash of arrogance. Second step is to figure out whether you are getting those returns consistently. Knowing your benchmark can help you a taking more risk than necessary.

One of the investors that I know who believed that what has worked in the recent past will surely work for him again made an aggressive investment in F&O in May. But later, this is what he had to say “I had made 50 % returns in just 15 days but now I have lost 200% because of the leverage” said one investor. I will never invest in the stock market again”. This is a common response like the one from jilted lovers who say “I will never fall in love again”. Well I better not comment on the love factor but one thing I know for sure is that this mistake of not understanding the nature of the investment and completely blaming the asset class altogether does far more damage than anything else. At the end of the day “Failure is an opportunity to begin again more intelligently”.

I have used an anecdote from the book the Intelligent Investor by Benjamin Graham that sums up my point “I once interviewed a group of retirees in BOCA RATON, one of Florida’s wealthiest retirement communities. I asked these people mostly in their seventies – if they had beaten the market over their investing lifetimes. Some said yes, some said no; most weren’t sure. Then one man said, “Who cares? All I know is, my investments earned enough for me to end up in BOCA”. Could there be a more perfect answer. After all the whole point of investing is not to earn more money than average, but to earn enough money to meet your own needs.

As Ben Graham says “The best way to measure your financial success is not by whether you are beating the market but by whether you have put together a Financial Plan and a Behavioral Discipline that are likely to get you where you want to go”.

In the end what matters isn’t crossing the finishing line before anybody else but just making sure you do cross it.

Now how do you figure you are taking too much risks. 3 Simple questions might help.

• Have I lost sleep during the May crash or in general after making the investments?
• Do I feel pressurized to watch stock prices, fund NAVs weekly or daily?
• Do the UNKNOWNs given above worry me about my financial future?

If you have answered yes to either of the above 3 questions, you have taken more risk than you can digest.

If you answered yes to all the above, then like the kiddy line “it’s time to put your toys away” - it is time to put some of your stocks/equity funds away. As F Scott Fitzgerald said, “If you don’t know who you are, the stock market can be an expensive place to find out”.

- Amar Pandit

The author is a practising Certified Financial Planner.

Be cautious while investing in MFs

If you are not very knowledgeable about the stock markets, mutual fund is the best alternative available. But, be aware that investing in mutual funds does have a few disadvantages too.

Mutual funds are slowly becoming a preferred way of investing in equity by retail investors. This is quite welcome, given the benefits that mutual funds offer.

Professional management, diversification, transparency, affordability and convenience are some advantages, which have been highlighted time and again. Investors who wish to invest small amounts; are not very knowledgeable about the stock markets; and cannot devote much time to research and follow-up, would find mutual funds to be quite an attractive proposition to participate in the equity markets.

Investors in mutual funds should, however, be aware that investing in mutual funds does have a few disadvantages too. They must, therefore, do adequate research to minimize the impact of such negative factors.

Over Diversification

The fund may become very popular and attract lot on investments. Therefore at some point the corpus size may become too large vis-à-vis the investment opportunities available. The fund manager would, then be forced to invest in average stocks also, as he would have already reached the prescribed limits for the quality stocks.

Or the fund manager may take a cautious route and invest in much larger number of stocks than what is actually warranted for the purposes of diversification.

This can hurt the overall returns that the fund could have otherwise generated by limiting its exposure only to above-average stocks.

Higher concentration

Contrary to the above, it may also happen that the fund manager may take a much larger exposure to select industries, thereby exposing the fund to concentration risk.

If your risk appetite is low or possibly you have already invested in a few sector-specific stocks, then this particular fund may no longer be suitable to your overall investment pattern.

Idle Cash

All funds must keep some amount of the corpus in cash/cash equivalents to take care of the day-to-day redemptions. If this amount is large, it means that the fund is forgoing the opportunity to earn higher returns.

However, care must be taken to see whether this is a permanent feature of the fund or only a temporary phase. It is possible that the fund manager expects the markets to fall. Therefore, he might have booked profits by selling off a part the portfolio and is waiting for an opportune moment to re-enter the market at lower levels.

Fancy Names

Mutual funds have been marketing their funds under very fancy and catchy brand names. These could sometimes mislead the investor in understanding the real objective of the fund.

The investor, therefore, must read the prospectus to find out the exact nature of the fund and then decide whether it suits his investment objective or not.

Moreover, there could be a perception difference in what you believe the name stands for and what the fund’s intention actually is.

Higher expenses

As compared to direct investing into equity, one has to generally pay a higher cost at the time of investing. Typically, brokerage for direct purchase could be about 1% maybe even less, whereas entry load in a mutual fund could be around 2.25%.

Second, in mutual funds one would have to pay on-going annual fund management charges of about 2.5%, which is nil if you have brought shares and these are lying in your demat account. Moreover, these fund-management expenses are payable even if the fund has failed to perform, which would further reduce your already below-normal profits or maybe even add to your losses.

Loss of control

When investing in a mutual fund, you are effectively handing over the charge of your money to a fund manager. You are, therefore, dependent on the fund manager’s investment philosophy to generate returns for you.

Some investors may not be comfortable with this kind of passive investing. They would rather like to be in full control of their investment decisions.

One must keep the above issues in mind, when investing in mutual funds. However, given the fact that the advantages of a mutual fund far outweigh these negatives, they are still the best alternative available.

Moreover, given the easy liquidity, it is possible to sell and move to other funds, in case such disadvantages become too much of a drain on the returns. One must, therefore, be diversified across various funds and actively review one’s portfolio say at least 1-2 times in a year.

- Sanjay Matai

The author is an investment advisor

Invest, but choose the right mutual fund

Mutual funds can provide solutions for most of your investment needs; however, the key is to choose the right funds, and monitor them. Hemant Rustagi explains how to improve your returns with MFs.

Mutual funds have emerged as the best in terms of variety, flexibility, diversification, liquidity as well as tax benefits. Besides, through MFs investors can gain access to investment opportunities that would otherwise be unavailable to them due to limited knowledge and resources. MFs have the capability to provide solutions to most investors’ needs, however, the key is to do proper selections and have a process for monitoring. Let us see how MFs can make a difference to an investor’s financial planning and its results.

Planning for long term objectives

Many people get overwhelmed by the thought of retirement and they think how will they ever save the huge money that is required to lead a peaceful and happy retired life. However, the fact is that if we save and invest regularly over a period of time, even a small sum of money can suffice. It is a proven fact that the real power of compounding comes with time. Albert Einstein called compounding "the eighth wonder of the world" because of its amazing abilities. Essentially, compounding is the idea that one can make money on the money one has already earned. That’s why, the earlier one starts saving, the more time money gets to grow.

Through mutual funds, one can set up an investment programme to build capital for retirement years. Besides, it is an ideal vehicle to practice asset allocation and rebalancing thereby maintaining the right level of risk at all times.

It is important to know that determination and maintaining the right level of risk tolerance can go a long way in ensuring the success of an investment plan. Besides, it helps in customizing fund category allocations and suitable fund selections. There are certain broad guidelines to determine the risk tolerance. These are:

Be realistic with regard to volatility. One needs to seriously consider the effect of potential downside loss as well as potential upside gain.

Determine a "comfort level" i.e. if one is not confident with a particular level of risk tolerance, then select a different level.

Regardless of the level of risk tolerance, one should adhere to the principles of effective diversification i.e. the allocation of investment assets among different fund categories to achieve a variety of distinct risk/reward objectives and a reduction in overall portfolio risk.

It helps to reassess risk tolerance every year. The risk tolerance may change due to either major adjustment in return objectives or to a realization that an existing risk tolerance is inappropriate for one’s current situation.

Diversify across Market caps

Market cap of a company signifies its market value, which is equal to the total number of shares outstanding multiplied by the current stock price. The market cap has a role to play in the kind of returns the stock might deliver and the risk or volatility that one may have to encounter while achieving those returns. For example, large companies are usually more stable during the turbulent periods and the mid cap and small cap companies are more vulnerable.

As regards the allocation to each segment, there cannot be a standard combination applicable to all kinds of investors. Each one of us has different risk profile, time horizon and investment objectives. Besides, while deciding on the allocation, one has to keep in mind the fact whether the allocation is being done for an existing investor or for a new investor. While for an existing investor, the allocation that already exists has to be considered, for a new investor the right way to begin is by considering funds that invest predominantly in large cap stocks. The exposure to mid and small caps can be enhanced over a period of time.

It is always advisable to take help of professionals to decide the allocation as well as select the appropriate funds. However, investors themselves have an important role to play in this process.

All award-winning funds may not be suitable for everyone

Many investors feel that a simple way to invest in mutual funds is to just keep investing in award winning funds. First of all, it is important to understand that more than the awards; it is the methodology to choose winners that is more relevant. A rating firm generally elaborates on the criteria for deciding the winners i.e. consistent performance, risk adjusted returns, total returns and protection of capital. Each of these factors is very important and has its significance for different categories of funds.

Besides, each of these factors has varying degree of significance for different kinds of investors. For example, consistent return really focuses on risk. If someone is afraid of negative returns, consistency will be a more important measure than total return i.e. growth in NAV as well as dividend received. A fund can have very impressive total returns overtime, but can be very volatile and tough for a risk averse investor.

Therefore, all the award winning funds in different categories may not be suitable for every one. Typically, when one has to select funds, the first step should be to consider personal goals and objectives. Investors need to decide which element they value the most and then prioritize the other criteria. Once one knows what one is looking for, one should go about selecting the funds according to the asset allocation. Most investors need just a few funds, carefully picked, watched and managed over period of time.

Evaluate Portfolio performance

It is important to evaluate the performance of the portfolio on an-going basis. The following factors are important in this process:

Consider long-term track record rather than short-term performance. It is important because long-term track record moderates the effects which unusually good or bad short-term performance can have on a fund’s track record. Besides, longer-term track record compensates for the effects of a fund manager’s particular investment style.

Evaluate the track record against similar funds. Success in managing a small or in a fund focusing on a particular segment of the market cannot be relied upon as an evidence of anticipated performance in managing a large or a broad based fund.

Discipline in investment approach is an important factor as the pressure to perform can make a fund manager susceptible to have an urge to change tracks in terms of stock selection as well as investment strategy.

The objective should be to differentiate investment skill of the fund manager from luck and to identify those funds with the greatest potential of future success.

- Hemant Rustagi

The author is CEO, Wiseinvest Advisors Pvt. Ltd.

Hi

Your article is very informative specially for people like me.

Regards
Milind