In an article "Who cares for mutual funds" (Business Standard, September 1), Subir Roy takes what participants in the stock markets call a contra view - an approach contrary to popular belief and understanding to get the best results for the investor.
Let us look at what Mr Roy says while restricting himself to discussing investments in equity-focused schemes.
There are more than 3,000 mutual fund schemes compared to some 500 actively traded shares and, therefore, it is difficult to select the right mutual fund scheme. If one can research mutual fund schemes, it is possible to research stocks too.
The questions are: what is the right tenure of the investment and how does the churn get affected by the performance of the scheme? The performance of the scheme can be affected by a change in fund managers. Choosing stocks of the 20 best-known companies and holding them for a long term are more likely to give handsome returns compared to returns from mutual funds.
This is a crude way of looking at mutual funds, which is arguably the simplest, cheapest and the most regulated way of creating wealth. Let us see why.
Researching mutual funds is a very simple thing: pick up five or six of the most well-known fund houses and you can be confident of robust system and processes with well-defined products with a consistent performance.
Compare this with picking stocks: it involves numerous variables from understanding financial ratios, to the business franchise, to the global macroeconomic environment. It is not possible for a lay investor do so. After all, even equity research analysts specialise in a limited number of adjacent industries.
Though there are more than 3,000 mutual fund schemes, these are well classified across the risk-return spectrum. Choosing two or three different schemes in each category from the well-known fund houses is far simpler than choosing the top 20 companies that will best negotiate vagaries of economic change over the next five to seven years. Unlike stocks, good mutual fund schemes come at no extra cost. On the contrary, they have the wherewithal to keep costs in check.
Organisations with well-established processes, which India's better-known fund houses can now claim to have, do not let their investment performance suffer because of a change in personnel. Such organisations neither create nor promote rock-star fund managers.
Investing in index funds is a passive way of participating in the market and they are judged by how closely they track the respective index. However, the better performing schemes have for the larger part of the last few years outperformed the market. Therefore, passive investments are yet to become attractive in the domestic markets.
A lay investor should arrive at an asset allocation for her investment portfolio depending on her risk profile and returns requirement. Some model asset allocations suggest a 70 per cent exposure to equity and the rest to debt for an investor in her late twenties or early thirties. The allocation to equities reduces progressively as one grows old.
The investor should review her asset allocation once every quarter and rebalance her portfolio to the model asset allocation. This approach helps book profits and enables higher investments when equity markets are doing badly. This discipline frees one of the decisions of the tenure of investments and insulates one from any mis-selling.
Fortunately, the Indian mutual fund industry has evolved greatly in the last few years and the regulator has pushed it to become more transparent and investor-friendly. This ensures that many investor misgivings are addressed. Though there have been quite a few cases of miss-selling, expected regulations and guidelines for mutual fund advisors will largely address this issue.
Investment is a science, it cannot be done on the basis of one's perceptions of companies or the economic environment. It needs expert advice and holding directly held securities in ones portfolio is for the high-net-worth individuals who can afford it.
For lay investors, mutual funds are the best vehicle to participate in the capital markets. Mutual funds bring with them the advantages of professional management. They offer high liquidity and reduced costs because of economies of scale and most importantly, reduce risk through adequate diversification.
For small investors, a systematic investment plan while sticking to the discipline of reviewing and realigning the asset allocation is the best way to create wealth.