Mutual funds attract a mixed crowd of customers: corporates, institutional investors, businessmen, brokers, mutual funds themselves, housewives and salaried individuals.
Even the most intelligent among these have some notions about fund investing that can severely effect the quality of their investments. Notions that have been formed on the basis of persistent marketing campaigns or on old beliefs and half truths that appear to be full truths. It only takes simple mathematical calculations to find out whether these notions are valid or they are just plain myths.
Myths that can be injurious to your financial health and are difficult to get rid off—because they are often self-inflicted. We tested five common misconceptions of fund investing with data and are happy to debunk them for you.
MYTH 1
Larger funds generate big returns
Buster — Chances of large corpuses having higher returns are distinctly lesser than smaller corpuses.
You would believe that the fund with the largest asset under management (AUM) would also be the one returning stupendous returns, right? Wrong. Just because the elephant is one of the biggest animals, it’s not necessarily the fastest and the most agile. Managing a large corpus is difficult, especially in the Indian context, because of the relatively limited spread of the stock universe available for investment. Here’s the proof.
HDFC Equity is the largest equity-diversified fund scheme with an AUM of Rs 4,516.6 crore whereas in the last one year the highestreturning equity-diversified fund is JM Basic with an AUM of just Rs 150.63 crore or 3.5% the size of HDFC Equity fund.
Even the MONEY TODAY-Value Research ranking of top equity-diversified funds shows (table below) no correlation between the fund size and returns. The list has three funds with less than Rs 20-crore AUM, posting returns equivalent to those that are 100 times bigger in size. Only three of the 10 largest AUM funds are present in the top 10 list of funds that posted highest returns in the past one year.
So next time a fund sales person tries to impress you with the size of a fund scheme, you know what figures to quote back to him.
MYTH 2
Topper today = topper tomorrow...
Buster — Short-term toppers may not hold good in the long run too.
Funds that feature in list of top five and top 10 performers in a calendar year are unlikely to find themselves on the list in the second year. A study conducted by Prasunjit Mukherjee, CEO, Plexus Management, a mutual fund tracking firm, found that there was only a 50% chance of the best short-term performing fund delivering in the long-term.
The study was done for threeyear periods ending between March 2003 and March 2006. The table below shows how many times the top 10 funds, over a threeyear period, made it to the top 10 list.
MYTH 3
Fixed deposits are better than MIPs
Buster — MIPs are tax efficient and hence earn better over bank FDs.
Abank fixed deposit (FD) is a savings plan that earns a fixed return on the corpus, an MIP on the other hand has a variable earning that is linked to stock market fortunes, economic scenario and the fund’s performance and charges.
We looked at how MIPs have fared over the last three years and found them to be always better than bank FDs. Post-tax returns are even higher for MIPs as tax rates on FDs are higher. In the year with a high FD interest at 9%, the effective return post-tax returns works to 6.6-6.8% compared to 7.6% for an MIP. So if you are looking for regular income, MIPs are better instruments to look into.
MYTH 4
Mutual funds hold diversified portfolios
Buster — Even equity-diversified mutual funds have sector and company bias.
People sometimes equate investing with gambling because both appear to deal with the element of chance. It is true that if you have no education to guide you in investing, especially asset allocation and you blindly follow the trend, you might as well be closing your eyes and rolling dice.
Equity-diversified mutual funds are sold on the premise that they broaden asset allocation through intelligent diversification. But the truth isn’t exactly quite that. We explored the sector and stock allocation for the top five equity-diversified schemes from our rankings to find:
So, what does it all signify? It tells that there are commonalities in stock and sector selection across mutual funds. If you are hoping for asset allocation and diversification through mutual funds, trudge with caution. Investing in nine equity-diversified funds with the same theme or five different debt funds doesn’t work—that is diversification in numbers, not in concept.
But having a mid- or small-cap fund along with an equity-diversified fund, or a growth fund or an income scheme with a closed-ended fund is diversification by kind and it helps shelter you against the risk that everything you own will drop at once.
MYTH 5
Closed-ended funds offer better returns compared to openended ones
Buster — There is no evidence to prove this. On the contrary, the reverse seems to have a higher occurrence.
We looked at closed-ended and openended schemes across fund types for a one-year and three-year returns. This is what we found:
Besides better returns, it’s easier to get in and out of open-ended scheme, with no time bars on purchase or redemption.
The bottomline? Mutual fund companies go to great lengths to create brand names in a mostly homogeneous industry.
Barring the worst funds, the performance of most funds in a particular style or category can be expected to fall within a narrow range of returns over the medium- to long-term tenure. It has to be this way, as there is only a finite selection of stocks to choose from in each category.
Nevertheless, fund companies will say anything to stand out from the pack. This is an effort to break myths that have been ingrained because of the zealous fund distributors who churn your portfolios to profess myths that erodes investor wealth.
