Are Mutual Funds Safe?

Are mutual funds safe? No it is not! Mutual funds are subjected to all investment risks that your underlying investment asset class is subject to and many more.

Going back to the fundamental investing rule - High Risk = High Return; Low Risk = Low Return. Your returns are the rewards for managing the risk of an asset class. So if you are earning any kind of return from your mutual funds (which in most cases you are), there is a risk associated with them.

The question should not be: Are Mutual Funds safe? Which are the safest Mutual Funds? You must understand the underlying risk of these mutual funds and invest in them based on your risk taking capacity. 

How to Check the Risk of Investing in Mutual Funds? 

Riskomter in fact sheet  - As per SEBI's product-labelling guidelines, AMCs have started disclosing the new riskometers for their funds. The five risk levels are ‘low’, ‘moderately low’, ‘moderate’, ‘moderately high’ and ‘high’. This helps investors get a better picture of the right risks associated with a particular fund. You must check the riskometer to get a brief idea of the risk of the particular mutual fund scheme.

Standard deviation - A fund's standard deviation tells you how volatile or risky a fund can be compared to the benchmark and its peers.

When prices move wildly, standard deviation is high, meaning an investment will be risky. Low standard deviation means prices are calm, so investments come with low risk. Instead of just looking at the standard deviation of a fund, you should compare the standard deviation of a fund with the standard deviation of the benchmark index to get a better idea of the risk

When it comes to Debt Mutual Funds, there are some specific factors that one can check to know the underlying risk of the same i.e.

1. Credibility of the fund

Debt Mutual Funds can invest in securities with different credit ratings, as per the scheme's investment strategy. The credit rating of the security is listed alongside its name in the mutual fund factsheet. These ratings are assigned by different rating agencies and indicate the credit worthiness of the borrower. Higher the rating, higher is the creditworthiness of the borrower, although the returns may be lower as compared to a bond issued by an entity that has a lower rating.

2. Duration of the fund

SEBI has defined categories of mutual funds based on maturity or Macaulay duration of the fund. Put very simply, Macaulay Duration is the time taken for a bond to repay its own purchase price in present value terms. Generally, the longer the maturity of the instruments that the mutual fund holds, the higher the Macaulay duration of the fund. Typically the longer the maturity/duration of the fund, the higher the expected returns. But higher duration also leads to higher volatility in returns with change in interest rates.

Simply put, ultra short duration funds, liquid mutual funds being the one with the shortest duration and underlying better credit securities (you must check the portfolio before investing) are the safe debt mutual funds to invest in. That is why we generally recommend these for any short term goals and emergency fund needs of our investors. 

You can learn more about the underlying risk of Investing in Equity - here and Investing in Debt - here

Wealth Café Advice: 

As explained above, mutual funds are not safe, there will always be a certain level of risk in them. You must analyze that risk based on your risk taking capacity and invest only in those funds which you understand and are okay to bear/manage the risk to achieve your goals. Do not invest in small cap funds or thematic funds because they are trending and you are a conservative person. The funds will trend while you will have sleepless nights. You can’t entirely escape risk, but you can always manage it.  Understanding your risk capacity is the very first key step to help investors gain without pain. -What is a Risk profile? How to Invest basis that?

 

Check our course- NM 104: Basics of Mutual Funds - to learn more about Mutual Funds in detail.

 

 

Disclaimer: - The articles are for information purposes only. Information presented is general information that does not take into account your individual circumstances, financial situation, or needs, nor does it present a personalized recommendation to you. You must consult a financial advisor who understands your specific circumstances and situation before taking an investment decision

 

Investments / Mutual Funds - 12/02/2021

What are the factors you must check when you are looking at a mutual fund?

Are you someone investing in mutual funds using app filters like 4-5 stars or sorting it based on highest to lowest returns? Do you invest in mutual funds with low NAV and believe you bought it for cheap? Do you feel that lower the expense ratio of a mutual fund scheme, cheaper the investment for you? Do you make mutual fund investments based on hearsay or advice from your relatives, colleagues or train companions? Or, are you investing in the Best 2021 Mutual Funds suggested on someone's Instagram reels?

Well, if your answer to any of the above questions is yes, then you are at the right place. Selecting a mutual fund is an art and science that is tough to learn but rewarding in the long run.

FACTORS TO CONSIDER

Personal Needs: Your Individual requirements

  1. Investment Objective - Every investor has an objective, a set of goals behind their investments. We all save and invest money to achieve our goals such as travelling, buying a car, buying a house etc. If nothing, then the basic objective of achieving wealth creation or financial freedom is a must for everyone. So before you start your investment it is important to pen down your goals along with the amount needed for that goal. You can learn more about this on this article here - Goal based investment
  2. Goal Tenure - Once your objective is in place, you need to calculate the time required to achieve that goal. It will also help you to choose the right investment for you. Simply put - short term goals - invest in debt ; long term goals - invest in a mix of debt & equity as per risk profile.
  3. Risk Profile - Now that you know the amount you need and when you need it, the next step is to understand your risk profile i.e. how do you want to reach the amount that you need. You must understand how much risk you are comfortable taking to achieve your goals. A person with an aggressive risk profile has a higher risk taking capacity and can invest, say 80% of his savings, in equity whereas a conservative person would invest a lot less in equities. The idea is that you take only so much risk that allows you to sleep peacefully, invest consistently and have a smooth ride to achieving your goals. Know more about your risk profile and how it helps you invest better in this article - What is a risk profile? How to invest basis that?

Quantitative factors: Evaluating the Fund

1. Past Return Performance

Past performance of a Fund is a starting point of what to expect from investing in a fund. However, ensure that you do not look at this number in isolation.

  • Every mutual fund scheme has a benchmark against which it tracks and evaluates its performance. Check how the mutual fund scheme has performed compared to its benchmark. Has it been under-performing its benchmark or been able to beat the benchmark consistently?
  • You should then check the returns of the mutual fund in comparison to other funds in the same category. If you are choosing a Large cap fund, you must check how well your fund has performed in comparison to other large cap funds.

All this while you must bear in mind that there is no guarantee of the past performance of the fund being repeated in the future.

2. Risk Statistics

Risk is uncertainty and variability in returns. Returns are the result of managing the risk. Some of the statistics that will help you understand the risk your fund is taking to achieve the returns you just analyzed include:.  

  1. Standard Deviation: It measures the mutual funds’ investment risk and is indicative of the stability of returns of a portfolio. With this information, you can judge the range of returns your fund is likely to generate in the future. Higher the standard deviation of a fund, higher is the risk associated with the investment.
  2. Beta: It measures volatility of the fund compared to its benchmark. If the beta of a scheme is more than 1, then the scheme is more volatile than its benchmark. If beta is less than 1, then the scheme is less volatile than the benchmark. Lower the beta, lower the risk associated with the fund. 
  3. Sharpe Ratio: Unlike the previous two measures, the Sharpe Ratio gives you the risk adjusted returns of a portfolio. If two funds have similar returns, the one with the higher standard deviation will have a lower Sharpe Ratio. A fund with a higher Sharpe Ratio is considered better than its peers as it is able to deliver higher risk adjusted returns.

3.  AUM of the Fund

AUM is the total amount invested by that particular fund. It is the total market value of the assets that a mutual fund manages at a given point in time. 

Only because a Fund has a large AUM, it does not mean it is a good Fund. You need to consider other factors as well. Having said that, avoid Mutual Fund Schemes that have a very small AUM as the returns from such schemes can be very volatile and subject to large movements on exit by large investors of that scheme.

4. Cost of the fund:

As with any business, running a mutual fund involves costs. This cost is called the Expense Ratio. If you have 2 identical funds w.r.t. to the above discussed parameters, then you choose the fund with the lower Expense Ratio. Check out our article to understand it more in detail

III. Qualitative factors: Fund Manager and Fund’s philosophy

The fund manager is the professional who takes the investment decisions for your money after you invest in a scheme. The fund manager plays a key role in how your investment performs, as he/she is the person to decide on which stocks or securities to invest and how to distribute the money for a particular mutual fund. 

Obviously the Fund manager is not alone and he has a team helping him do the analysis and his decisions will be based on the Objectives of the particular Scheme and the overall Fund Management philosophy.  

Apart from looking at the qualifications of the Fund Manager, you must look at his experience and how long he has been managing the Mutual Fund Scheme and the performance of the Fund under him. Longer his tenure with the fund with a consistent performance should give you confidence in selecting the Fund.

A strong Mutual Fund team, guided by well defined Investment Fund Philosophy will be a great aid to an experienced Fund Manager.

Wealth Café  Advice: 

These pointers will give you a headstart to start evaluating the various Mutual funds schemes and shortlist them. You need to regularly track these parameters of your invested Funds, track the Fund Managers and see how your Fund is performing vis-à-vis the market. 

If your day to day job does not give you the time to keep a track of your funds, you can always consult an expert whoa will do this for you. If you want us to manage your investment, you can learn more about us at ria.wealthcafe.in and reach out to us.

Check our course- NM 104: Basics of Mutual Funds - to learn more about Mutual Funds in detail.

Disclaimer: - The articles are for information purposes only. Information presented is general information that does not take into account your individual circumstances, financial situation, or needs, nor does it present a personalized recommendation to you. You must consult a financial advisor who understands your specific circumstances and situation before taking an investment decision.

 
Mutual Funds - 11/25/2021

How are investors buying mutual funds - looking at the best performing ones?

The first thing to answer before you start investing is to know “WHY” you are investing in Mutual Funds.

  1. Debt Funds - To build a safety net, achieve short term goals and earn higher tax efficient returns compared to  fixed deposits.
  2. Equity Funds - To create long term wealth and achieve goals

 

Many Investors just look at the best performing funds. They would google - Top 5 funds for 2020 or Top 5 funds for 2021 and invest their money in the fund names that appear. So much so that most of the time they do not even remember the name of the fund. So many times, we have asked people - which fund have you invested in and I would get an answer saying - Umm HDFC bank? Kotak? Something DDFC…basically full confusion and no research.

 

Yes, when you don't know how to invest and you want to invest, choosing the best funds based on recent past performance seems the easiest choice to make. However, it would also turn out to be a bad choice. 

 

Studies have proven that selecting mutual funds based on high-performance track records is naïve. The Star rating of various mutual funds keeps changing, a fund that is top rated in this one year, is hardly the top-rated fund in the subsequent years. Tim Courtney, a chief Investment advisor of US-based Burns Advisory, did backtesting of past performance of the funds most highly rated, he found that they usually performed poorly after they have gotten 5 ratings. Hulbert financial digest, an investment newsletter, found that if investors continually adjusted their mutual funds' holdings to hold only the highest-rated funds, a total stock market index would have beaten them by 45.8 % in the past decade (he studied funds from 1994 to 2004 in the USA). In fact over the years, it has gotten even more difficult to beat the markets and get alpha on your investments.  - extracts from Millionaire extracts - How to build wealth living overseas by Andrew Hallam

 

Recently, even ET money conducted a similar study for the Indian Mutual Fund market and tracked the returns investors would make. As per the study, they tracked that if investors followed a buy and sell strategy with top rated mutual funds i.e. they bought the best fund and then sold them when their rankings fell, they would make a CAGR of 12.6% in the past 10 years (without accounting for the cost of investing, selling and taxation on the same). Now, instead of doing this, if the investor would have only invested in an index fund in the past 10 years (2010 to 2020), they would have made a return of 12.2%. 

 

The cost of transactions such as brokerage, exit load, STT and capital gains taxes (payable every time you book gains on mutual fund transactions) would further reduce your returns in case of a buy and sell strategy based on the top ranking fund. Also, it is not feasible to follow this approach once your portfolio grows too much.

 

Some learnings from the above 2 studies are as follows:

 

  1. Chasing past performance and looking out for best returns is a futile activity, it is not giving you better performances. It is only tiring you and keeping you away from focusing on important parameters.
  2. Invest as per your goals and risk profile, finalize the funds and stick to them. Rather than looking for quick gains, understanding wealth creation takes consistency and discipline is the way.
  3. If you want to learn on what parameters to check to select the right fund (please stop using the word best funds), check our blog  - Factors to check.
  4. If you really want to invest and make a financial plan - you can reach out to us by filling this google form or at iplan@wealthcafe.in We are SEBI registered investment advisors and can help you make sound investment decisions. You can read about our advisory services at ria.wealthcafe.in

 

Wealth Café Advice -  “Past performance is no guarantee of future results.” In search of looking for the best, you are missing on the right and the time a fund needs to create wealth and achieve your goals.

 

Check our course- NM 104: Basics of Mutual Funds - to learn more about Mutual Funds in detail.

Disclaimer: - The articles are for information purposes only. Information presented is general information that does not take into account your individual circumstances, financial situation, or needs, nor does it present a personalized recommendation to you. You must consult a financial advisor who understands your specific circumstances and situation before taking an investment decision.

Mutual Funds - 11/23/2021

How long should you stay invested in mutual funds?

The struggle to stay committed to investments is as real as it is to stay committed to a human. How long your relationship with your mutual funds is a function of your need for that investment and your risk profile. 

 

Based on tenure of your goals

 

Invest based on your goal tenure: Investing is very simple if we understand all the rules. Goal based investing is based on the tenure of your goals.

  • Short term goals are less than 3 years goals.
  • Long term goals are more than 3 years goals

 

Invest in mutual funds by first identifying for which goal you are investing, what is the tenure of that goal and then invest till that goal is accomplished. Now where you invest to achieve that goal is a function of your risk profile. (we have discussed that here)

  • Short term goals are less than 3 years goals. - Debt Mutual Funds (short term)
  • Long term goals are more than 3 years goals - Mix of debt & Equity (as per your risk profile)

 

Invest in Equity for long term for higher gains and managed risk

 

Invest in equity for the long term to reduce the risk of investing in equity. Compound and grow your wealth and eventually achieve your long term goals. Lets understand how your long term goals will be achieved by investing in Equity. 

 

For instance, in 2010, if Rakhi had a goal of financing her child’s education and back then she knew that 12 years later i.e. in 2023 for her child’s Graduation, she would need around 1 crore for the same she would invest in the below mentioned manner (based on our recommendations)

 

From our savings calculator, you would have known that you need to invest INR 42,000 each month for the next 10 years (based on the assumption that you have a growth profile and would earn 12.6% returns from the same).

 

Now based on our investment plan - she would put 70% in equity and balance 30% in debt. Hence, from INR 30,000 if she invested 21,000 in Nippon India Growth Fund ( a mid cap Mutual Fund) each month for the past 10 years and stayed with the fund through all ups and downs, she would have made 17.10% return. Do note that when you are investing for a long term goal it will eventually turn into a short term goal and in the last 2 or 3 years remaining for the goal, you must shift your investments to debt and discontinue investing in Equity.

 

Hence, in case of Rakhi, she would invest in Nippon India Growth Fund till 2021 and then discontinue the same. For 2021, 2022, and 2023, she would invest the entire 30,000 INR in debt.

 

As per the returns, in 2021, she would have an equity corpus of INR 98.31 lakhs and a debt corpus of INR 21 lakhs. A total of INR 1.19 crores was accumulated in 2021. Given the goal is 2 years away, we advise Rakhi to gradually move her Equity exposure to debt to avoid any last minute volatility. Where the goal's value would have changed and Rakhi decides to continue her 30,000 investments, she can invest the same in Debt. 

(image from value research)

 

Please note that the context of this article is that you must invest for the long term in Equity only where your goal is long term. Over the long term, the risk of equity also reduces as we can see in the case of Nippon India Growth Fund from the image above. Long term investing results in higher gains due to compounding. Still people do not make returns, because they cannot stay committed to their mutual funds.

 

Do people actually stay invested for long term

Nippon India Growth Fund, launched in October 1995 as a mid-cap scheme, completed 26 years in October 2021 delivering a compound annual growth rate (CAGR) of 22.91%. Since launch, the fund has grown 207 times over. In other words, ₹1 lakh invested in the fund at the start would now be worth ₹2.07 crore.

However, according to data released by the fund house, only 2,600 investors have stayed with the fund since inception and their average assets under management (AUM) is a mere ₹5 lakh. In other words, this cohort of patient investors would have invested just ₹2,415 on average at the time when this fund was launched. (source of this data is from mint - https://www.livemint.com/mutual-fund/mf-news/nippon-amc-sheds-light-on-missing-mf-millionaires-11634232789297.html)

The effect of your money staying invested for longer is far more than getting in at the right time. Not many investors had stayed put for more than 15 years. Unfortunately, people try to time the market. The fund had been managed by various fund managers over time, and has weathered numerous economic events, including the dot com bust, the 2008 crisis, 2013 taper tantrum and covid in 2020.

Wealth Café Advise:

As investors, learn to be more disciplined and focused on the long term and do not get carried away by market volatility.

According to the study conducted by Axis Mutual Fund, four behavioral traits affect investors’ returns:

  • They overreact to market sentiment.
  • They focus too much on short-term market or fund performance.
  • They don’t follow an asset allocation strategy.
  • And, finally, they tend to invest haphazardly, rather than systematically.

 

Check our course- NM 104: Basics of Mutual Funds - to learn more about Mutual Funds in detail.

Disclaimer: - The articles are for information purposes only. Information presented is general information that does not take into account your individual circumstances, financial situation, or needs, nor does it present a personalized recommendation to you. You must consult a financial advisor who understands your specific circumstances and situation before taking an investment decision.

Mutual Funds - 11/17/2021

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