Investment in mutual funds

While it offers the protection of investing in many stocks, that protection could fail in the event of a bad market.
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Representational ImageFile/GK

We have been witnessing powerful advertisements (ads) campaigns unleashed by the Mutual Fund companies, promoting the ‘charm’ of Systematic Investment Plans (SIPs). The campaign is influencing the retail investors’ investment decision, luring them to invest almost blindly in mutual funds mostly through SIPs. 

Notably, SIP is simply an investment route that leads the investors to invest a fixed amount regularly in mutual fund schemes, mostly in equity mutual fund schemes. Here the investors do not need to invest in lumpsum, instead they can stagger their investments in equity mutual fund schemes over a period. Actually, the SIP has been designed to get small  and salaried investors, who basically don’t possess financial strength to invest in lumsump, into the fold of the equity market. 

The ad campaigns present the investment in mutual funds especially via SIP route safe as well as most profitable investment.The impact of these ad campaigns has been so powerful that banks’ recurring deposit (RD) scheme is receiving mild response from the depositors now, as most of their depositors have been preferring SIP over RD scheme.

However, the safety of investment in mutual funds, especially in SIP bears question marks. Even as the mutual fund industry is growing exponentially as it has successfully attracted millions of new raw investors, growth in wealth creation for investors is not guaranteed.

While looking at the market scenario, mutual fund management in the recent past faced rough weather and most of their schemes under-performed. A report revealed ‘around 44 per cent of the open-ended diversified equity mutual fund schemes failed to beat their benchmark’. An open-ended mutual fund scheme is one that is available for sale and purchase on demand at net asset value (NAV). These schemes do not have a fixed maturity period.

Normally, investing money in a bank through schemes like RD lends a comfort to the depositor that the money is safe in the bank as it stands insured and there is no such history on record when depositors’ money was not returned by a bank on demand. On the other hand, investment in mutual funds is not insured. We always hear the fund managers talking of high returns in mutual fund schemes, but hardly we hear any probability of losing the investment from them.

So investment in mutual funds and through SIP does not guarantee that investors won’t lose money. In fact, in certain extreme circumstances investors could lose all money. Notably, every such scheme by virtue of regulations carries a disclaimer notifying that investment can lose value. While mutual funds offer the protection of investing in many stocks, that protection could fail in the event of a bad market.

Some time back, the investors of debt mutual funds were shocked when HDFC and Kotak Mutual Funds’ fixed maturity plans (FMPs) failed to return investors’ entire money on account of delay in repayment by two Essel group companies. In the past too, investors in various debt schemes have been affected by ratings downgrades of investments, defaults or delay in repayments.

When we look at the performance of mutual funds, we find these funds haven’t been able to garner the same kind of trust. A lay investor would not like to lose his money and he’s forced to accept the market fluctuation. Among other things, quick-money schemes and chit funds have taken their toll on mutual funds where investors were looted in the name of high returns. 

What is a debt fund?

A debt fund is an investment pool, such as a mutual fund or exchange-traded fund. Often referred to as credit funds or fixed income funds, its core holdings comprise fixed income investments parked in short-term or long-term bonds, securitized products, money market instruments or floating rate debt.

In simpler terms, the funds which invest in instruments like corporate bonds and securities, not in stocks are known as debt funds.

Here it makes sense for naïve retail investors to understand the collapse of Franklin Templeton debt fund schemes. Understanding this failure of the well-known mutual fund house can act as a guiding investment principle for the investors. Normally, people follow success stories to understand the process of achieving financial goals through investments. But in the COVID-19 induced situation, a look at the failures of even established systems and procedures can go a long way to realign the processes to mitigate risks to a large extent.

Notably, Franklin Templeton debt fund schemes collapsed following a dramatic and sustained fall in liquidity in certain segments of the corporate bonds market on account of the COVID-19 crisis and the resultant lockdown of the economy.

Does this mean  safety of investment in mutual funds bears question-marks?

When compared to other investment instruments in the capital market, mutual funds are a better option for an investor as far as risk is concerned. While no investment is 100% risk-free, the investors have to look out for the best-performing mutual funds and for that consulting a financial consultant is the best choice.

So, what matters is the choice of platform you would choose to park your money. While looking for hefty returns on your investment, you have to take higher risks. Simply, the choice is yours.

It should also be noted that in certain extreme circumstances investors could lose all money. Every mutual fund scheme by virtue of regulations carries a disclaimer notifying that investment can lose value. This means, any guaranteed protection could fail in the event of a bad market. In other words, any catastrophe can lead to failure of the economy, making every investment worthless and wipe out all the money, be it invested in a mutual fund or any other capital market instrument.

One more thing, at least bank upon mutual funds which are consistent in performance.  Any short-term scorching performance of a fund should not be taken as a basis for investing in the scheme. Time horizons for performance review as well as for achieving objectives need to be longer.

Meanwhile, investors don’t need to panic every time their mutual fund goes down in value, unless there’s some bad scenario that makes them think their investment is in trouble. Any fund can go down in value temporarily. When there is a drop, investors should immediately look at the scenario to check if there’s something they should be concerned about. Otherwise, that would merely be normal movement of the market.

When are mutual funds considered a bad investment despite a positive market scenario?

As mentioned above, investment in mutual funds is relatively safe. but it proves a bad investment when issues such as high expense ratios charged by the fund, various hidden front-end, and back-end load charges, lack of control over investment decisions, and diluted returns crop up.

For instance, a mutual fund is not a good choice for a market participant, especially when it comes to fees. It includes a high annual expense ratio or the amount the fund charges its investors annually to cover the costs of operations, and load charges, or a fee paid when an investor buys or sells shares of a fund.

Experts are of the view that excessive annual fees can make mutual funds an unattractive investment, as investors can generate better returns by simply investing in broad market securities or exchange-traded funds.

When investing in a mutual fund, it’s important to go deep into the fund’s investment strategy and see which index fund it may be tracking to see if it is safe.

DISCLAIMER: The views and opinions expressed in this article are the personal opinions of the author.

The facts, analysis, assumptions and perspective appearing in the article do not refl ect the views of GK.

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