“Today there is a major aspirational class in India that wants to invest for growth….According to the Association of Mutual Funds, the assets under management of the mutual fund industry in India in 2014 were around 10 lakh crores. In these eight years, by June 2022, it has increased by 250 percent to 35 lakh crore. That is, people want to invest. They are ready for it”. This is Prime Minister Narendra Modi speaking at the inauguration of the International Bullion Exchange in GIFT City, Gandhinagar on July 29, 2022. These are not words that India has ever seen coming from the political leadership. To the contrary there has been a deep-seated suspicion of markets in general and stock markets in particular. This discomfort with markets has led to decades of sub-optimal investment options for Indians wanting to keep savings ahead of inflation.
The closer you examine the financial sector, the more you get to believe that parts of the industry believe that if there is a way to do something wrong, why do it the right way? Not for all the firms in the market, but a few aggressive ones. And these cause regulators to go on tightening rules that finally hurt the market as the compliance costs and complexity keeps growing. The first 10 days of October saw the market regulator in an overdrive to push through long-pending reform that make the mutual fund product safe for retail investors. The speed could have some connection with the date of whole-time member Madhabi Puri Buch’s term completion coming closer, though she recently got a one-year extension. Buch has been a prime driver of change in the last couple of years and has also energized the mutual fund department into a data-crunching, evidence-building and change-enforcing machine. These are all good things for investors, of course. Three changes and what they mean for you.
An average person needs between 10 and 15 financial products to manage the complexity of contemporary life. A few decades ago, when the government was the main employer and would guarantee returns, it was easy to just leave it to the government to fix your life if you were lucky enough to be in the network. Those outside just got by with their own savings in gold, real estate and bank deposits. Opening up the markets boosts both incomes and choices. It pours millions of people into the middle class that consumes not just pizzas and gyms, but also financial products. But given the complexity of the market, even willing on-boarders to formal finance find it difficult to choose. One way to solve this is to have generics in the financial sector. Just as generics cost much lower as compared to branded pharma, we can think of generics that do the basic function without the bells and whistles. What a Jan-Dhan Yojana did for banking can be done by similar products in insurance and market-linked investment.
The problem with getting a message on the phone that demands an instant list of five funds to invest in is that there are no ready names to give. Likewise, for tweets and other social media requests for names of two or three funds to invest in, there is no easy answer. Similar is the problem of somebody asking for a life insurance or a health insurance plan—how does one recommend a single product to a person who knows something about the product but not enough? They don’t know that anybody who takes the risk of advising without knowing more is not acting in their best interest. Mutual funds and individual insurance products have made it into the attention spectrum of the financially included, mostly urban middle-class Indians, but the on-boarding is still difficult, precisely because each person needs a unique solution according to his or her personal situation, goals, risk capacity and profile, but is unwilling to pay for advice and is looking for a quick solution. But there are no quick solutions in personal finance and most people find that the hard way.
Why should a business paper get into the business of short-listing investment-worthy mutual funds? I ask this question, not from the readers’ point of view, but from our own. The whole thing is fraught with problems that make the final list almost not worth the effort. First, what if despite the hard work of putting in place number-based filters (returns, risk and portfolio characteristics) and then making the shortlist of funds jump through the qualitative hoops (that includes talking to the fund managers and other information sources), some of the funds that get on the list mis-fire? That you end up with egg on your face is a minor problem, the bigger issue is that it affects real money of real people who have trusted you. While there is no foolproof way to give a 100% risk-free portfolio without it being only made of government securities, we do recommend holding at least two funds from each category to reduce the risk of a particular scheme malfunctioning due to factors beyond reasonable control. Therefore, diversification across asset classes, within asset classes and across fund houses is recommended.
The Infrastructure Leasing and Financial Services (IL&FS) contagion is spreading. After mutual funds and non-banking financial companies (NBFCs), it is the turn of the exempt pension funds to be worried about their investment in bonds from the beleaguered institution. The story is: as non-performing asset-laden banks dried up lending to firms, these companies turned to other sources of money as a firm needs working capital to keep the wheels of business turning. Money comes from two sources—extra funds that other firms have and household savings. Institutions such as banks, mutual funds, insurance firms, pension funds, and NBFCs act as intermediaries between households, who are the lenders, and firms who are borrowers. In the IL&FS case, there are bonds that have not kept to the interest payment schedule and were, thus, classified as below investment-grade by credit rating firms. Once that happened, the exposure to such bonds held by mutual funds came to light. Next came the exposure of NBFCs to these bonds.
We’re at the mid-point of this series already! I’m talking about risk in mutual funds in this episode. Don’t miss! and we are introducing a new co-anchor Disha Sanghvi
“Don’t invest in mutual funds if you are nervous about your short-term emergency needs,” she advises. Watch the full video for more.
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Indian retail stock and bond investors may not have heard the name, but John C. Bogle (called Jack) impacted the way mutual funds are constructed, cost and sold all over the world. The founder of the $4.9 trillion Vanguard Group died on 16 January, a little over three months short of his 90th birthday. Bogle straddles the fund management world like a colossus, having turned an industry on its head more than 30 years ago by thinking of and acting in the interest of the retail investor. He did this by focusing on whittling down costs in two ways. One, to cut out the star fund manager and introduce index-based investing with wafer-thin costs. Two, to cut out the distributor and go “no-load”—where shares are sold without a commission or charge.
The year 2018 taught us that buying last year’s winner is not a good idea. Several years of good returns, a successful ‘mutual funds sahi hai’ campaign and the spread of the SIP culture brought plenty of first-time investors into equity mutual funds. The SIP book grew 50% over calendar year 2017 and another 20% in 2018 despite choppy markets. New investors rushed in and some of them went straight to the winners of 2017—the mid- and small-cap mutual funds. Some of these funds had given returns of over 40% in 2017 inducing investors to throw caution to the winds and rush to the risky part of the equity market. Investors made two errors. One, bought last year’s winner in 2018. Two, allocated all their equity investment to the past winner.
The year 2018 was when we all learnt some hard money lessons. We learnt that stock prices that go up very fast can zoom down too. We learnt that debt funds are not fixed deposits and returns are not assured. We learnt that real estate revivals can take years and years, and 2018 was not that year. We learnt that governments can change the rules of the game around taxation making it better or worse for you. 2018 was the year in which we learnt the meaning of risk.
There were four kinds of risks that we took home this year. First, the risk of chasing high returns. Many of you may be holding a portfolio that has mostly small- and mid-cap funds. That’s because you saw the 40% plus one year returns in 2017 and went all out to harvest that return. I can remember plenty of conversations with first-time mutual fund investors who had jumped right into the deep end with all their money in the risky part of the market. Warnings would fall on deaf years as the return chasers thought the SIP was their safety belt. 2018 saw a bloodbath in both the mid- and small-cap categories. Investors are staring at an average loss of 12% in mid-caps and around 18% in small-caps. The worst small-cap funds have lost almost a third of the invested value—or ₹1 lakh has become ₹70,000. If you had your entire money in small- and mid-caps, your portfolio is bleeding. But if you had a mix of large-cap, multi-cap and ELSS funds, the red will be less stark. Just buying last year’s winner is not a good strategy for mutual fund investors. 2018 told us that. Understand what a ‘diversified portfolio’ means and implement it in your money box.