“I invested my retirement monies in mutual funds in 2006. All my investments are showing a loss. I will never invest in mutual funds again”
“I chose mutual funds to create a corpus for my daughter’s wedding. The investments I made in 2007 are languishing at half the value. I regret investing in mutual funds”
These are some of the testimonials that routinely appear in newspapers and television shows nowadays. While the facts of each case differ, the underlying message is the same - mutual funds are to blame for all investor woes. Although slamming mutual funds (equity funds in particular) is in vogue at the moment, we believe there is a case for adopting a more pragmatic approach while evaluating mutual funds and the investment proposition they offer.
Simply put, equity funds offer investors the opportunity to invest in equity markets in a convenient manner. The onus of making investment decisions (which requires a fair degree of expertise and experience) is shifted to the fund house and the fund management team. And for availing the fund house’s investment expertise, the mutual fund investor bears a cost in terms of loads and fund management fees.
Mutual funds also offer investors the benefit of diversification. For instance, a diversified equity fund typically invests in several stocks from across market capitalisations and sectors. Hence despite investing in a single fund, the investor benefits from the presence of a number of stocks in his portfolio.
So what went wrong?
Few would dispute that mutual funds offer investors an attractive investment proposition. So what went wrong? Nothing. While the investment proposition offered by mutual funds remains unchanged, market conditions have changed. After witnessing an almost secular bull run for nearly 5 years, the stock markets crashed sharply in 2008. From their peak in January 2008, markets have fallen by over 50% till date. Mutual funds being market-linked avenues have expectedly borne the brunt of the falling markets as well. For investors who became habituated to seeing their mutual fund investments clock attractive growth in a seamless manner, the crash in stock markets (and its severity) has come as a rude shock. As a result, mutual funds are being seen as villains and harbingers of misfortune.
At the core of this problem lies lack of complete and accurate understanding of the investment proposition offered by mutual funds. For instance, in several cases, distributors and investment advisors failed to impress upon investors the risks involved; instead, they were guilty of only emphasising on the returns aspect. Then there were instances of mis-selling as well. Investors with modest or no appetite for risk-taking were persuaded to get invested in equity funds and at times even in sector/thematic funds (which are typically suited for informed and risk-taking investors). Finally, investors need to accept a share of the blame as well, for having failed to make informed investment decisions.
Is it curtains for mutual funds?
Given the kind of doomsday scenario predictions that are doing the rounds, several investors are being led to believe that it’s the end of the road for mutual funds. Is that a correct assessment? We don’t think so. Let’s take a look at the performance of some well-managed diversified equity funds with a 5-Yr track record. From the diversified equity funds segment, we have chosen a motley mix i.e. large cap, mid cap and opportunities style funds.
Diversified equity funds: Long-term players
Equity Funds NAV (Rs) 1-Yr 3-Yr 5-Yr
DSP BlackRock Top 100 (G) 49.90 -46.1% 9.2% 20.4%
HDFC Top 200 (G) 90.17 -46.3% 4.8% 19.9%
Sundaram Select Midcap (G) 59.49 -58.4% 2.3% 19.8%
Sundaram Select Focus (G) 50.87 -52.5% 8.7% 19.7%
HSBC Equity (G) 58.64 -48.8% 5.0% 19.3%
ICICI Pru. Dynamic (G) 48.62 -46.2% 6.2% 18.5%
HDFC Equity (G) 107.92 -50.6% 1.1% 17.7%
DSP BlackRock Opp. (G) 39.44 -54.5% 0.9% 17.1%
Franklin Bluechip (G) 99.08 -49.1% 3.4% 16.4%
Sundaram Growth (G) 48.93 -57.2% 1.0% 15.2%
BSE Sensex -52.4% 2.0% 12.8%
(NAV data as on December 12, 2008. Growth over 1-Yr is compounded annualised)
Over 1-Yr, the performance of funds across the board leaves a lot to be desired. For instance, the ‘best’ performer has posted a loss of 46.1%; the worst performer’s NAV has fallen by 58.4%. The showing over 3-Yr is nothing to write home about either. However, the 5-Yr performance for all the funds is quite impressive. The entire peer group has delivered in the range of 15%-20% (on a CAGR basis). Notwithstanding the recent downturn, the performance of funds over longer time frames continues to be noteworthy. Over the long-term, well-managed diversified equity funds have commensurately compensated investors for the risk borne by them. This only reinforces that equity investments must be made for and evaluated over the long-term. While over shorter time frames equity as an asset class can expose investors to high risk, its ability to deliver over the long-term is undisputed.
What investors must do
To begin with, investors would do well not to panic and make any ill-advised investment decisions. Instead, they must conduct an honest evaluation of their risk appetite and find out if their investment portfolio is in line with the same. Investors who do not have the requisite risk-taking ability or investment horizon, and yet are invested in equity funds should consider making necessary modifications to their portfolios.
Investors who are convinced that equity funds should find place in their portfolios need to evaluate the chosen funds. They must ensure that the funds they are invested in are suitable for them; this in turn will entail understanding the investment proposition of the funds.
Finally, investors must engage the services of a competent investment advisor. Not only can the advisor help investors select funds that are right for them, he can also aid them in reviewing the portfolio which is critical to the investment exercise.
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