Mutual fund myths

These are just some common comments often heard about mutual funds on the street. For years, mutual funds in India simply meant the units of the Unit Trust of India UTI, the country8217;s first mutual fund institution that was a monopoly. UTI units carried an unsaid government guarantee on return. So people began to look at units of mutual funds as they do at bank deposits, except that units gave excellent returns and deposits did not.

The public sector funds and then finally the private sector funds, had a heavy cross to carry 8211; to match the government-aided performance of the UTI. Learning curve errors, mismanagement and market factors, all added to the problems of the mutual fund industry in the initial years. The collapse of UTI8217;s flagship scheme, the US-64, made the already skittish investor even more paranoid about funds.

But UTI is now walking a different road, as are the private sector funds. The regulator has made the road signs fairly clear and an accident like 8216;vanishing companies8217; will not happen in the mutual fund industry, though loopholes will always be found to increase business and profits. Though the underlying situation has changed, the investors continue to live in the past. Here are some popular misconceptions and why they are wrong.

A mutual fund is an equity product
When people think of funds they think of only equity funds, but the truth is that a mutual fund is a vehicle that can carry any passenger. Equity mutual funds will buy shares off the stock markets and debt mutual funds will buy into debt products like government bonds, corporate debentures and treasury bills. The risk of each kind of fund will depend on the passenger carried by the bus. If it is treasury bills, then the short term risk is very low and the principal is safe, if it is longer duration debt, then the risk is slightly higher, but not as high as an equity carrying fund. Within each category, there will be funds with higher or lower risk. For example, in equity, sector funds will be more risky than index or diversified funds. Says A P Kurien, Chairman of the Association of Mutual Funds in India AMFI, 8220;in India, less than 15 per cent of all mutual fund investments is in the equity markets, the rest is in the debt market 8211; government bonds, corporate paper and the like8221;.

Mutual funds are very risky
You may have seen or heard the warning: 8216;mutual funds are subject to market risks8217; on television or in a magazine. Does this mean that all mutual funds are very risky? No. The warning only means that the funds cannot promise guaranteed returns to the investor. There is risk, but it is lesser than the risk of going to the market directly. At the same time, the risk is more than that of investing in a government bond or bank account. Market regulator, the Securities and Exchange Board of India SEBI says, 8220;Investments by mutual funds in securities are spread across a wide cross-section of industries and sectors and thus the risk is reduced. Diversification reduces the risk because all stocks may not move in the same direction in the same proportion at the same time8221;.

Mutual funds are for the experts
Quite the reverse, actually. Unlike the equity market, you don8217;t have to take the call on when to buy or sell shares. The fund manager will do it for you. It is his job to track various sectors and companies, and decide where to put the money you and other investors have given him. However, that does not mean that once you have bought mutual fund units, you can abdicate all responsibility. You must follow the fund8217;s performance from time to time. Compare the returns you are getting from your fund to the average rate of return in the market. This information is available in your daily newspaper and on mutual fund specific websites.

Mutual funds give low returns
It really depends what you compare your mutual fund returns to. If you compare returns from a debt fund to the stock market returns, these returns will look low. Compare like with like. Look at the returns given by debt funds with the returns you get on your bank deposit or bonds. Compare equity fund returns with returns given by the market index. Remember, if your fund returns look lower than returns made by some direct equity investors, your risk is also lower since a fund, by nature, is a diversified product and diversification can lower both risk and return.

I am locked in
Only if it is a tax-saving fund, that has a lock-in, the rest are open to redemption 30 days after the initial public offer. The indirect lock-in comes through exit loads that are deferred. A load is a charge on the buying or selling price 8211; the NAV 8211; of a fund to take care of distribution costs faced by a fund. A load on the buying price is called an entry load and a load on the selling price is called an exit load. Some funds to encourage investors to stay longer, put such a load in place. In some cases this load decreases with time. Called a Contingent Deferred Sales Charge CDSC, such a load rewards a longer holding period by reducing the exit load, sometimes to nil.

I cannot sell a part of my holding
Mutual fund units are so finely sliced that you can trade upto four decimal places. For example, if you want Rs 5,000 from your fund and you have 1,000 units that have a current NAV of Rs 25.34, you can sell 197.316 units to get your target amount. In fact, SEBI guidelines stipulate that equity funds must disclose NAV at least upto two decimal places for all funds, and upto four decimal places for debt funds. No other financial product is so divisible. Can you imagine selling one room in a flat to get some money!

Funds are one of the best vehicles for people who don8217;t have either the expertise or the time to take care of their own investments. Belief in these myths prevents you from using funds as an efficient way to mange your money. Uncover the truth, unmask the myths.