Mutual Funds Mythbuster
By Ramalingam K.,
an MBA (Finance) and Certified Financial Planner,
the Founder and Director of Holistic Investment Planners
ramalingam at holisticinvestment in
www.holisticinvestment.in
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Rahul is working for a mutual fund house. They have recently
came out with an NFO (new fund offer). The day on which the fund
house announced its maiden NAV (net asset value), he received lot
of calls from investors asking why the NAV is at below par. They
thought something was wrong.
Then Rahul went on clarifying them that though both an equity
fund and a stock extend market-related returns, there are some key
differences between the two. If you have similar misconceptions
about equity funds and stocks, this article will demystify all those
misconceptions.
New Fund Offerings:
A new fund offer is not likely to generate amazing returns as
can be the case with an initial public offering from a company.
This is because the NAV reflects the market value of the stocks
held by the fund on any day. Because a fund holds several stocks
in its portfolio, the NAV can only reflect the combined returns
on the portfolio between the NFO date and the date of first NAV.
The first NAV declared by a fund can, at times, be lower than
the par value of investment. A lower NAV does not mean a cheaper
fund: Just because a New Fund is issued at Rs 10, it does not mean
it has a chance of giving better returns than an existing fund that
has a higher NAV.
Whether the scheme in which you are planning to invest has an
NAV of Rs.15 or Rs.150 does not matter at all.
There is a difference between the price of a listed security and
the NAV of a mutual fund scheme. Listed security has a price, determined
by the demand and supply of the security. Whereas the unit's NAV
of the scheme has a value determined mathematically, by the prices
of the securities in the portfolio. If the portfolio appreciates
by 10% Rs.15 NAV will become RS.16.5 and Rs.150 AV will become Rs.165.
So in whatever the NAV you invest your investment will fetch you
10% return.
So instead of concentrating on LOW NAV and more number of units,
it is worthwhile to consider other factors (performance track record,
fund management, volatility) that determine the portfolio return.
A fund with higher NAV may give higher returns than a lower NAV
fund, if its stocks did better in the markets.
Funds Vs Stocks
| Point of distinction |
Equity Fund |
Stocks |
| Level of Risk |
High |
Highest |
| Entry/Exit cost |
No Entry Load; But there will be Exit load. Advisory fee
may be applicable. |
Demat a\c and Brokerage charges |
| Options |
Options available like dividend payout, dividend reinvestment,
growth. |
No such options |
| Minimum Investment |
Min investment is usually Rs.5000. |
Even one share can be bought. |
| Measuring Performance |
Returns Vs Benchmark |
Net Profit margins/EPS |
| Sub-division |
Classified based on stocks in which it invests. (Diversified,
Midcap, sectoral, thematic) |
Classified as per the industry in which it operates.(FMCG,
IT, PSU, METAL) |
| Pricing |
Based on the price of the underlying securities |
Based on the demand and supply of the particular stock |
Dividends are not extra returns:
Immediately, after the dividend payment of dividend the NAV of
the fund will fall to the extent of the dividend payment. Let us
illustrate.
Fund’s cum dividend NAV is Rs.25. Proposed dividend is 50%. You
are investing Rs.1 Lac and you will not get Rs.50000 as dividend.
It is only Rs.20000 (50% on the face value Rs.10 is Rs.5 per unit)
as the unit price is Rs.25 you will get 4000 units. Rs.5 dividend
* 4000 units=Rs.20000.
And this dividend is not an additional gain or income. After payment
of dividend the NAV of the scheme will fall to the extent of the
payment and distribution taxes (if applicable). Now your nav will
become Rs.20 and your investment value will be Rs.80000 (4000 units
* Rs.20 NAV).
In a nutshell,
Investment amount Rs.1,00,000
Dividend amount Rs. 20,000
Present Value Rs. 80,000
It is nothing but investing Rs.80000 after dividend distribution
at NAV Rs.20.
So investing in a scheme because it is declaring dividend in the
near future is meaningless.
Usually a company with a liberal dividend policy may enjoy greater
investor interest in the stock market. The same is not applicable
to an equity-oriented mutual fund.
Investing more number of funds is not actual diversification.
It may reduce your return.
Owning several mutual funds doesn’t necessarily broaden your holdings.
It will be a mistake to buy the same securities over and over again
in different funds with different names. You tend to believe they're
diversified. But it is not real diversification.
There are only very few funds which are performing consistently.
Instead of investing in few funds, if someone chooses to invest
in more number of funds (because he intends to diversify) he may
be forced to choose some average performing schemes also. As a result
his returns will be diluted. The step taken by the investor to diversify
his investment is not leading to diversification but to dilution
of return.
Thus ideally your portfolio should not have more than four-five
funds.
NO tax for churning:
When we buy shares and sell them within a year we are accountable
for short term capital gain tax at the rate of 15%.
But mutual funds provide the benefit of churning of stocks with
no tax implications. A fund which churns its portfolio within a
year is exempt from tax because it only redistributes these profits
to investors.
The author is Ramalingam K, an MBA (Finance) and
Certified Financial Planner. He is the Founder and Director of Holistic
Investment Planners (www.holisticinvestment.in) a firm that offers
Financial Planning and Wealth Management. He can be reached at ramalingam
at holisticinvestment in.
Published - March 2012
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