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Words of Wisdom : "No matter how great the talent or efforts, some things just take time. You can't produce a baby in one month by getting nine women pregnant." ~ Warren Buffett

Mutual Fund Queries: You Ask. We Answer.

Among the many queries you asked with respect to your mutual funds, I list below a few of the important ones for the benefit of one and all. This, of course, is besides the detailed solution to the new tax laws on debt and other non-equity oriented mutual funds [See 'Many ways to rejig Debt MFs post-budget']

Q 1. As Mutual Funds is something I am not very familiar with, I try building my portfolio based on the industry ratings and returns. And, my investment initially will be limited where I shall roll around my MFs.
 



A 1. There are certain misconceptions here that should be clarified
- Mutual Funds are supposed to be for long term. So this "roll around" concept is wrong for MFs
- Selling after a year and reinvesting is not the right way to long term wealth creation from MFs
 

Further, ratings and returns are not the only parameters to select funds. One has to take a comprehensive look at Performance, Risk Parameters, Portfolio Characteristics, Economic Scenario etc. For example, till a few months back infrastructure funds were the worst performers. But in anticipation of the new stable Govt. they have delivered 30%+ returns in last few months. 

Or, at peak interest rates long term income funds are the worst performers. Yet as rates fall they will deliver the best returns. All this cannot be captured in ratings / returns. Remember, investment has to be done based on certain assumptions about the future, not what happened in the past.


Q 2. In your blog 'Why even the best mutual funds failed to make money for Jiten Singh?' I didn't understand this: "In a mutual fund, the fund manager is also precisely doing the same. He is regularly booking profits by selling overvalued stocks and buying the under-valued ones. Therefore, despite the fact that its NAV may have gone up, the particular MF may still be a good buy as its ‘new’ portfolio is under-valued." Are you saying that portfolio that I saw while buying MF is not same throughout? The fund manager keeps on buying and selling stocks in the portfolio? Doesn't that have any effect on NAV?

A 2. Well, one cannot have a static portfolio. With time, some businesses prosper and some suffer; some become overvalued, some undervalued; some businesses disappear, some are created. Unless the portfolio is modified in line with these changes it will never deliver returns.

In fact, this is where the expertise of the fund manager lies. He monitors the portfolio and makes appropriate additions and deletions from time to time. Of course, he has to maintain the fund's stated philosophy. So a large cap fund will restrict itself to large cap companies; a pharma fund will not invest in non-pharma companies.

Suppose a fund has a corpus of Rs.3000 crores and the fund manager sells some shares worth Rs.200 crores and buy different shares for Rs.200 crores. So the total corpus hasn't changed. Neither have the no. of units issued. So the NAV also won't change with such buying / selling by the fund manager. NAV changes with the appreciation / depreciation in the prices of the underlying shares.


Q 3. In selection of equity funds (apart from mandate, fund manager and performance), should Fund Management Charges (FMC) be a criteria? Does FMC vary significantly that it needs attention or it is a competitive space and all funds are in a narrow range? How much FMC varies for debt funds and equity funds on an average? Is it right to say that with equity funds, investor not only takes higher risk (of capital) but also bears higher cost of fund management?

A 3. All funds have a narrow range as the FMC is capped by SEBI guidelines. Therefore, after shortlisting the appropriate funds based on the important and relevant parameters, one can probably opt for those with lower charges. Though it can also be safely ignored. This is for equity funds. However, for debt funds, where the returns range from 6-9%, FMC and Exit Loads are an important selection criteria.

FMC for debt funds may ordinarily vary from 0.5% to 2%. Equity may vary from 1.5 - 3%. Since equity funds require much more active management and much closer monitoring than debt funds, it is quite logical that they should carry higher cost.


Q 4.  I have been investing in MFs for more than a year. My goal was to invest Rs. 15,000 a month through SIP for 5 years. And right now the markets are at all time high. Initially I expected the return to be 12-15% but right now my portfolio is up by 25%. I am kind of confused about what should I do now?  Should I book some amount of profit or should I let it grow? I am thinking in terms of analogy that you once mentioned. To get the taste of fruits, you need to let the plant grow to full potential and give it time. I don't want to be greedy but at the same time, I don't want to miss the opportunity too. What are your suggestions?

A 4. First and foremost, one has to appreciate that there is no perfect solution. One can neither always buy at the bottoms or always sell at the tops. Markets will always be volatile. Sometimes they will deliver very high returns and sometimes very high losses. And there is no way one can match these timings.

Therefore, one has to shift the focus from the market to oneself. One has to decide on one's equity-debt ratio and stick it to by rebalancing the portfolio whenever it is distorted beyond a reasonable level. Rebalancing tells us whether to sell/buy equity and proportionately buy/sell debt. More importantly, it also tell us "how much" to buy / sell. This, in my opinion, is the more rational and scientific approach to profit booking.

By the way, it is wrong to say that the markets are high (or low) by merely looking at the Sensex/Nifty number. In case you missed, do read my blog 'Should I sell as the Sensex / Nifty is at an "all-time high"?'


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