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Learn to be trigger happy

Learn to be trigger happy

The trigger facility in equity funds helps individual investors rein in their impulses and book profits in a disciplined manner.

In the past few years, many retail investors have seen a dream run on Dalal Street turn into a nightmare because they failed to book a timely profit. It happened in January 2008, when the Sensex soared to 21,000 and then plummeted to 8,000 by October. This year, too, the BSE benchmark touched the 18,000 mark in mid-January, fell to 16,000, only to touch 18,000 once again. It's a frequent misadventure suffered by individual investors as they find it difficult to rein in their greed when the markets are on a roll. To curb this tendency, several fund houses offer the trigger facility. It's a tool that allows the investor to set a target and redeem his investments if their value crosses a predetermined limit.

"Usually, investors don't book profits when the market is rising. Instead, they shift their target upwards," says Sanjay Parekh, senior fund manager, ICICI Prudential Mutual Fund. "Realisation sets in only when the markets undergo a correction and they end up losing their gains or even a part of their principal," he adds. Indeed, it is a rare investor who sells his stocks when the markets start moving up. As it's virtually impossible to predict the future movement of stocks, anyone who thinks he can time the market is fooling himself. According to experts, one should invest in equities with a long-term perspective, yet, periodic booking of profits is essential, especially in these volatile times. Unless an investment is redeemed, the profit remains only on paper. It is crucial for investors to know when to sell and realise the gains, especially if they have to reach financial goals. For mutual fund investors, this need to book profits is partly taken care of if they opt for the dividend payout option. However, the timing and quantum of the dividend payout is at the discretion of the fund house and the investor has little say in it.

It is here that the trigger facility offered by many fund houses plays a crucial role and empowers the investor. One can choose from a variety of customised triggers (see box). Some are based on price, others are linked to the percentage of returns, yet others are time-based.

Also, a trigger can be used for a particular transaction or a series of transactions during a specified period. For instance, an investor can opt to redeem all his equity fund units if the NAV crosses a certain level. He will not have to monitor the markets and then take an investment call. If the trigger has been activated, the mutual fund will automatically take the required action. So, if you had bought units when the NAV was Rs 10 and want to book profits when it reaches Rs 12, instead of having to keep track of the NAV and then submit a redemption request, you can set a trigger to redeem all units when the fund's NAV crosses Rs 12. The trigger level can range between 5 per cent and 100 per cent of the appreciation and enables an investor to save time on redemption formalities. "By predetermining a target, an investor avoids getting carried away by emotions. This makes the investment process more objective," says Parekh.

Most fund houses are offering this facility for their equity schemes. Newer fund houses, such as the Edelweiss Mutual Fund, offer more than 14 trigger options and 10 actions to choose from. You can redeem your entire investment or only your gains or even a certain number of units. You also have the option of switching to a relatively safer option, such as a short-term debt fund or a liquid fund, from the same fund house.

The trigger facility assumes greater importance in volatile times. If you opt to shift from an equity fund to a debt fund, the trigger will help you book profits, but ensure that your money continues to grow. You don't have to redeem the investment completely.

Activating the trigger facility is fairly simple. Just fill up a form specifying the action needed and submit it to your mutual fund. Make sure you understand how the trigger works. If you have opted for a one-time trigger, the fund will deactivate it once the action is completed. In case it is a repetitive trigger, the fund house will continue making the changes as specified.

A note of caution: the trigger facility should not be seen as a reason to invest in a fund. The Target Return Fund from ICICI Prudential AMC has a mandatory trigger option, under which the investment is shifted to a debt scheme after 12 per cent, 20 per cent, 50 per cent or 100 per cent appreciation. This compulsory trigger is only under the growth option. The unique feature that the fund offers is that it provides an entry trigger facility, which enables an investor to switch from debt schemes to the Target Return Fund on achieving predefined trigger levels. This trigger is based either on the BSE Sensex values (in multiples of 100) or a percentage drop (5 per cent, 10 per cent, 15 per cent and 20 per cent) in the NAV of the Target Return Fund.

However, the fund has not had enough time to prove itself and has underperformed the category since its launch in May 2009. Investors might be better off if they opt for an established fund that offers a trigger facility.

Experts also feel that triggers should be used only if the investor understands the implications. "Although the trigger facility is a good check on greed, it is counterproductive to long-term saving, especially if the investor does not know what to do with the money being withdrawn," says Dhirendra Kumar, CEO, Value Research.

It's important to keep the tax incidence in mind before setting a trigger. Whenever a redemption is triggered, the investor makes a capital gain or loss. If it is an equity fund and the investment was made over a year ago, there is no tax to be paid since long-term capital gains from equities are tax-free. Such gains are likely to be taxable once the Direct Taxes Code comes into effect next year (see Tax Watch, page 87). If the investment term is less than a year, 15 per cent tax is payable on gains from equity funds. This In the case of debt funds, the long-term capital gains are taxed at 10 per cent and short-term gains taxed at the marginal rate. An investor might also have to pay an exit load.

To overcome these problem, the Tata PE Fund from Tata Mutual Fund offers investors an automatic dividend trigger option. An investor can set a limit of, say, 5 per cent or 10 per cent of the NAV. As soon as the NAV crosses the threshold specified by the investor, a dividend is automatically paid from the NAV. This mode ensures a tax-free income in the hands of the investor because dividends are not taxable. However, one can receive a dividend only once in a quarter. "Pre-set dividend triggers serve as an effective hedging tool against the volatile nature of equities," says a fund manager at Tata Mutual Fund. The Tata Equity PE Fund follows an automatic profit booking strategy. The fund invests at least 70 per cent of its assets in shares whose trailing PE is less than that of the Sensex. If the 30 per cent limit for shares of higher PEs is breached, the fund needs to sell and rebalance.

Sometimes, the fund has an inbuilt trigger. The Franklin Templeton Dynamic PE Ratio Fund is a fund of funds that invests in equities based on the PE of the Nifty. When the Nifty PE is low, say 12-16, the fund invests 70-90 per cent of its corpus in equities. As the markets rise and the Nifty PE goes up, the fund progressively reduces its exposure. In early January 2008, when the Nifty PE was above 25, the fund had only 10-30 per cent of its corpus in equities.

Taking a cue from mutual funds, life insurance companies are also offering the trigger advantage to investors in unit-linked insurance plans (Ulips). ICICI Prudential Life Insurance allows investors in the Pru LifeTime Maxima Ulip to give instructions for automatic rebalancing of their Ulip portfolio. Under the trigger portfolio strategy, investments are distributed between the Multi-Cap Growth Fund and Income Fund in a 75:25 ratio. If the NAV of the Multi-Cap Growth Fund moves beyond the limit specified by the investor, the company rebalances the portfolio. "The idea is to protect the gains made in the equity markets from any future volatility and, at the same time, maintain a predefined asset allocation structure," says Pranav Mishra, senior vice-president and head of product and sales, ICICI Prudential Life.

7 types of triggers and how they work

1.Value trigger: Redemption/switch is triggered when the investment reaches a value defined by you.

2.Nav-based trigger: Comes into effect when the NAV hits a certain value or changes by a specified percentage.

3.Date trigger: Redemption/switch occurs on a date specified by you.

4.Capital gains trigger: Comes into effect when there is capital appreciation of a certain percentage or amount.

5.Reinvesting gains: Allows one to redeem or reinvest when the requisite period for realisation of long-term capital gains is reached.

6.Downside trigger: It's based on a stop loss concept, where one can specify the value or percentage that is lower than the investment amount.

7.Index-based trigger: Comes into play when the BSE/NSE rises by specific points or hits a certain level.