The mutual fund business as well as investors in mutual funds in India are under stress. It is not only the investors who got their fingers burnt, even fund houses too are seeing their assets under management (AuM) thinning down, thanks to a lingering bearish phase in the equity market.
Consider this. In April 2011, the total AuM of all types of mutual funds was Rs 785,374 crore, which dipped around 14 per cent to Rs 680,154 crore in April this year, according to data available with the Association of Mutual Funds in India (Amfi). What’s more, while the net monthly inflow into all mutual funds was Rs 184,331 crore in April 2011, it slipped to Rs 92,746 crore in this April, a decline of an 50 per cent.
Many retail investors are now in a fix. They wonder if they should stop investing further into schemes, switch to new ones or continue to pour in their money in the ongoing schemes and face the risk of further value erosion.
MM talked to experts to find out the ways retail investors can look at in order to sail through the rough waters. MM put forth before experts various cases representing different situations a mutual fund investor might find himself/herself in the current market conditions. Based on them, experts suggested various strategies an investor could adopt to brave the odds.
Patience is a virtue
Mr Average Urbanite (AU), the sole earning member of his family of four, lives in a small rented apartment in a Mumbai suburb. His long-term goal is his son’s higher education and his daughter’s marriage in around 10 years’ time. In order to build a corpus to meet his objectives and reap profits in the short term, he started a systematic investment plan (SIP) in two equity funds and one equity-diversified fund in 2010—the year when the Indian stock market was booming. However, the market meltdown in 2011 dashed his hopes. The NAVs of his funds have now dropped significantly.
He had hoped to redeem his funds’ units in a couple of years but is in a fix whether to stop the existing SIP or start a new one.
For an investor like AU, experts advise to keep patience and to have a long-term goal. As K Ramalingam, Director and Chief Financial Planner, Holistic Investment Planners, Chennai, says, “SIP in equity funds should be linked to your long-term goals. If you have invested for your daughter's marriage, it is expected 10 years from now. When you complete seven years of SIP, you will have three years to achieve the goal. Then it is no more a long-term goal. At that point of time, you need to stop your SIP in an equity fund. Whatever you have invested in the seven years, you need to start withdrawing in a phased manner using the systematic transfer or withdrawal plan (STP or SWP).”
He says when the SIP earns profit, you need to continue with it. But if it is incurring losses and the losses are because of market fall, then you can continue SIP in the same scheme. However, he adds that if the losses are because of the underperformance of the scheme, you need to consider moving out from the underperforming fund to a performing one.
According to Srikanth Meenakshi, Chief Operating Officer, Wealth India Financial Services, Chennai, whether an investor like AU should start investing in a fresh SIP or stop the existing one depends on the investor’s time frame and investment objective. “If he needs money urgently in, say, three months, he should stop and redeem his units. On the contrary, if the investor is looking at a longer horizon, there is no reason for him to pull out. However, if his SIP is in a poorly performing fund, he should take his money off,” he says.
“The fact to remember is that the fundamentals of decision making related to investment in all market conditions remain intact. This means that one should take a call on his investment in mutual fund considering three factors—the long-term performance of the fund, pedigree of the fund and time frame of his investment,” he adds.
Kartik Jhaveri, Director, Transcend Consulting (I) Pvt. Ltd., Mumbai, also advises an investor like AU to continue holding SIP even if he is in loss. “There are two important reasons a mutual fund investor chooses to invest through SIP—non-availability of lump sum to invest, and the benefit of rupee cost averaging. However, many investors don’t realize that SIPs need a longer term gestation period before they start generating returns than a regular or lump sum investment method. As a thumb rule, the average holding period in an SIP should be at least eight to 12 years with a couple of bear and bull phases in the market before one can expect good returns from it.” In other words, if an investor is not getting returns on his SIP that started a couple of years back, he should continue holding it even if there is a loss. In this manner, the investor can play the rupee cost averaging in the long term. “SIP is not a quick-fix game where one starts putting a fixed amount every month and expects returns immediately,” Jhaveri maintains.
Goal-centric planning
Ms Woman Professional (WP) is a mid-level marketing professional in a realty firm in Gurgaon. An aggressive investor and a believer in the value averaging investment plan (VIP), she put in her money in a couple of funds through the VIP route when the market was on a high level in 2010.
Maybe it was a big mistake on her part or bad timing, when she invested in equity funds in September 2010 the Sensex was above 20,000, but after that it started plummeting so fast that in December last year it dropped to a low level of 15,454.92. Now, with the Sensex is hovering around the 16,800 level, she is very upset. “It’s so frustrating. I don’t know what I should do with my VIP plan,” she rues. One big benefit of VIP is that instead of investing a fixed sum, one invests more when markets are low and less when markets are high. However, the flipside is that sometimes investors can face difficulty in managing the cash flows as the amount of investment is variable. Further, if the markets are moving in one direction VIP can end up giving less return than SIP. Another factor is that value averaging works better for investors who have a long-term investment horizon and not for short-term investors.
In the case of WP, the bad times struck from all sides—she was a short-term investor, and the market started steadily moving downwards after September 2010. The upshot: VIP proved disastrous for her.
So what should she do now? Experts say that in such cases, the next step depends on the investor’s goal. “The investor can continue to invest (as in the case of SIP) till he nears his goal,” advises Ramalingam.
Meenakshi of Wealth India Financial Services too favors continuing with the VIP strategy. “In the current market conditions since there is no fundamental shift in the factors related to investment decision making, one should continue to average through VIP,” he maintains.
Further, he adds, whether averaging would lead to bear trap conditions depends on when the investor wants the money back. The market cycle needs time to recover and, if an investor aims to generate return in a short period through averaging, he needs to wait for at least three to five years and not six months to one year to avoid being in a bear trap. “The thumb rule is that if you stick with the market, the market will stick with you.”
Think long term
Back in January 2006, Mr Confused Investor, an accountant in a public sector bank, invested Rs 20,000, the lump sum bonus he had then received, in a couple of growth funds. His investment did pretty well for the rest of 2006 and 2007, but 2008 began with a wave of bad news for the markets. The Sensex that was 17,648.71 in January-end 2008 plunged to 9,647.31 level in December-end that year, eroding his investment by almost 12 per cent.
However, things began turning for better in 2009 when the Indian markets rose again with the Sensex and the Nifty surging around 80 per cent and 75 per cent, respectively. CI thought his investment would grow manifold in just a matter of months. The year 2009 went on a high note, as did 2010 in terms of returns. His investment had grown by 30 per cent, thus making good for the losses he had incurred in 2008. But it was in 2011 that his investments started dwindling again. The NAV started falling and currently they are almost at par with 2006 level. Though he has not lost, his gains of 30 per cent are now down to just 3 per cent.
The MF was good and bad for him in different times. What should he do now? “If possible, the lump sum investor should try to average out with some more additional investment. He needs to wait. Patience pays in the stock market. The same thing applies to the dividend option investor also. He can consider reinvesting the dividend whenever he receives it,” advises Ramalingam of Holistic Investment Planners.
Jhaveri of Transcend Consulting too advises investors in growth fund to stay put. “Equity growth funds are a long-term investment instrument. And, therefore, if an investor invested a lump sum years ago in a growth fund whose NAV has dipped, he should continue to remain invested for another five years.”
However, he adds, that investing in a dividend option of an equity fund is a foolish strategy because it ultimately amounts to nothing to an investor. Dividends given by dividend funds are not like those given by stocks. Unlike stocks, in a dividend fund the investor often gets his own money back in the form of dividends. Besides, the declaration of dividend also brings down the NAV of the fund. Hence it’s better to switch into the growth option of the fund and stay invested for many years. “Please be careful of switching as you might have to pay exit load if this is done before 365 days. Also, take into account the capital gain liability before you switch,” he says. Meenakshi of Wealth India Financial Services advises investors to exit if the fund’s performance is poor within its own category. “The investor has to exit if the fund’s performance within its own category has not been doing well in the last two to three years. It doesn’t matter whether he invested in a growth fund or a dividend fund. In the case of dividend fund, the investor would have made some return on his investment in the form of dividends. So, to that extent, his losses would be minimized,” he adds.
“Also, if there is capital loss in the form of NAV decline, he can use that in his tax filing to offset any tax gains. So, the pain of having to redeem would probably be less in the case of a dividend fund. But the decision-making process should be the same for both growth and dividend options,” he says.
Don’t time the market
Mr Cautious Optimist (CO) is a junior HR executive in a small company in Kolkata. A bit new in the world of investment, he thought it as a wise decision to park his money in a debt fund last year as there was bloodbath on Dalal Street. While 2011 was a nightmare for equity investors, the market started moving upward in January this year, prompting CO to switch his investment from debt to equity fund in the hope that the market would roar back to life in 2012.
But that was not to be. Sensex has dipped around 2 per cent since January until June 20. Now, he is at a crossroads; the gains made from the debt fund have been eroded.
According to experts, CO’s biggest folly was that he tried to time the market by switching over. “You should not invest or change your asset class because of the underperformance in one asset class. If an investor switches like that, he may think that he is timing the market, but he is not. Time in the market is more important. One needs to choose an asset allocation and needs to stick to the asset allocation even during the tough times,” maintains Ramalingam.
Meenakshi of Wealth India Financial Services, however, maintains that the investor’s next course of action depends on his time horizon and investment objective. He says if he needs money now, he can exit but if he has long-term horizon, he can stay put.
Jhaveri of Transcend Consulting, on the other hand, adds that the investor in this case is not sure of what he wants and looks confused. “If he had invested in a debt fund expecting a higher return, he chose a wrong option. Later, he switched to equity fund expecting a higher return which again was a wrong decision. Many investors switch funds in expectation of a higher return which is a great folly. Investing in a mutual fund is for the long term and it’s very difficult to time your investment in volatile market conditions. If he is a conservative investor, he should have continued in a debt fund, whereas if he is an aggressive investor with a high risk appetite he should have continued in an equity fund,” he insists.
Is it time to switch?
Switch is an option available to the investor to shift his investment from one scheme to another within that fund. It allows investors to alter the allocation of their investment among the schemes in order to meet their changed investment needs, risk profiles or changing circumstances during their lifetime. The fund may levy a switching fee for exercising this option.
The recent instability in equity markets has compelled mutual fund experts to advice for switch. They believe that in the current scenario, for an investor who has a shorter investment horizon, switching over to a safer category of scheme will not be a bad idea. According to Anil Rego, CEO, Right Horizons, “If the investor has taken exposure to mutual funds over the past six months, it is likely that he may have made short-term gains on the invested amounts. It would be prudent to book profits and switch out from equities into debt for a portion of the invested amounts and switch back into equities at a later date.” Any redemption before 12 months of investment will be charged with short-term capital gains tax.
In the present interest rate scenario, Rego says, “if the investor has exposure in any form of short-term debt, it would be prudent to add duration by moving into long-term income funds, government securities funds, etc., since the rate cycle is likely to bottom out over the next 12-15 months.”
Actually, when interest rates begin to fall, new bonds will offer interest (coupon) in line with the new rates of interest, which would be lower. As older bonds that were issued in times of higher interest rates, would be offering higher coupons and therefore comparatively higher yields. So, the people will be willing to pay a premium to own the existing bonds.
Anil Kaul, the CFP with www.sahayak.com, feels, “Even the balanced fund would be a good option to switch at this stage. Our markets have not fallen much and have the potential to surge from just a single trigger. Seeing this, the investor should have some exposure towards equity.” A balanced fund (also known as hybrid funds) is a kind of mutual fund that invests in both equity and debt.
On the other hand, a bunch of experts also feel if an investor follows an appropriate asset allocation which suits his risk profile and also has longer investment horizon, there is no need to switch funds from one category to another even if the market situation changes. However, the investor is also required to select the best fund schemes which are acting in tune with his financial goals.
Further, analysts predict that market could continue to be extremely volatile in the near term and this could result in losses to existing value of the holdings in equity schemes. Hence the investors who have equity exposure to small/midcap funds must switch the same to large-cap oriented schemes. Historically, in a volatile market, small and midcaps plunge more steeply than large caps.
Is it time to redeem?
MF redemptions happen in two cases:
1) From the fund’s performance perspective, it happens if the scheme begins to underperform consistently or if the scheme’s mandate changes fundamentally.
2) From the investor’s perspective, redemption is done in cases where the investment objective has been met or if the portfolio needs to be rebalanced.
Redeeming MFs for reasons other than these would imply that the investor is trying to time the market using a subjective assessment, either their own or those of market experts. But then timing the market is not as easy as it looks.
Particularly, those who invest with long-term horizons, waiting for lower levels, may not bring much difference in profits. Therefore, it might not be a good idea to redeem one’s investment completely at this point of time. Financial experts believe one should book profit in a phased manner across all category of fund.
Currently, an investor of equity schemes, including sectoral and index funds, may redeem the profit part (if any), while an investor of debt scheme should stick with their holdings to gain from interest rate cycle (explained above). As gold is hovering around its all-time high of Rs 30,000/10 gm, those who have invested in gold ETF and gold funds may redeem their funds completely or should at least book profit at current levels. It would be wise for investors of gold to wait and see if the rate could come down a bit and then make fresh investments.
A few experts say that for those who have a long-term horizon, it would be sensible to raise cash levels gradually and start to deploy the money systematically back into equities over the medium term. DK Aggarwal, CMD, SMC Investments & Advisors Limited, says, “In the current situation, it’s prudent to employ the SIP strategy for equity funds. The SIP can give an opportunity to do bottom fishing and an investor can accumulate more units if the market falls.”
A long-term investor should rather stay invested in the best funds according to a proper asset allocation of the portfolio, says. “On the other hand, an investor with a short-term investment horizon can try to time the market as it can be fruitful in short term.”
Two issues which follow the decision of redemption are what to do with the redeemed money and when to reinvest it again. Any decision without proper thinking can lead to undisciplined pattern of investing, resulting in poor portfolio performance.
Is this time to buy a tax-saving plan?
Efficient tax planning enables us to reduce our tax liability to the minimum by legitimately taking advantage of all tax exemptions, deductions rebates and allowances and ensuring that our investments are in line with our long term goal. If the investor has a tax-saving need, it’s good for him to invest in the equity-linked savings schemes (ELSS). These schemes are no different from large-cap schemes and therefore investment into such schemes can be made at any point in time.
ELSS, popularly known as tax saving mutual funds, are a category where a major portion of portfolio is invested in equity and equity-related instruments. An investment up to Rs 1 lakh is exempted from income under Section 80C. Also, dividends received from ELSS funds are subject to tax exempt. In ELSS, there is a lock-in period of three years before one can withdraw.
Traditionally, tax-savings plans are sold in bulk during the last quarter of any financial year due to the year-end investing frenzy. Financial planners believe that in order to avoid the last-minute rush, one could look at planning the investment systematically into tax-planning schemes throughout the year. According to Aarun Joseph, Financial Planning Manager, JRG Securities, “A regular investment approach would be ideal while we invest in ELSS, as the investment should be in a time-bound manner.” Eleventh hour investments, done just for the purpose of saving tax, are not proper.
However, what is good about buying at the current level is, as markets are underperforming, the schemes are available at cheaper NAVs. One can probably make most out of it. But uncertainty is always there: what if market plunges more than the current level? To avoid this, an SIP approach would be better. Joseph says, “Once you work out the amount to be invested, you can have a systematic approach for the same.”
An SIP would take care of volatility in the index and will purchase units each month into your account. In this way, you don’t need to mark the timing for investment in ELSS, and there would be no need to rush for tax-planning products at year-end.
Rationale for creating a portfolio
The process of determining the kind of asset mix to hold in your portfolio is a very personal one. The asset allocation that works best for any investor at any given point in his life will depend largely on the time horizon of investment and investor’s ability to take risk. As a thumb rule, 100 minus the current age is the percentage portion of portfolio which should be allocated to equity.
For instance, someone at age of 30 may decide to invest with a goal. Most likely, his investment goal would be to achieve as much growth as possible—growth that will outpace inflation substantially. While aiming to reach this goal, he may allocate 70 per cent of his assets into aggressive growth stocks, 20 per cent into bonds and 10 per cent into money market instruments.
With this strategy, the investor will have years to ride out the wide fluctuations that come with stocks, but at the same time he will potentially lower his risk with bond and money market holdings.
Generally, as he reaches different stages of life, his investment goals will also change and thus will change his asset allocation. At 45, he will have a different investment needs altogether. He may now need to invest more in debt. Hence the rationale at any point irrespective of the market scenarios would be to estimate time horizon and the ability to tolerate risk. After all it’s not timing the market but time in the market that matters.
At a time when there is a high level of uncertainty and high volatility in the economy, it might sound risky to build a portfolio at this moment. However, a portfolio with a judicious mix of large-cap equity funds, and quality mid-cap funds, along with some exposure in debt and gold, can always provide for stellar returns over a time frame of three to five years.
“It’s very difficult for a retail investor to rely only on debt funds to get inflation-beating return. He has to take a chance into equity funds to get return over the inflation rate,” says Joydeep Bhattacharya, former CMO, UTI AMC. He advises that the current levels are attractive entry point for those who have an investment horizon for at least three years.
Asset allocation at this juncture would look like this—equity: 40 per cent in diversified equity (large-cap funds); debt: 30 per cent in long term debt (income funds); debt: 10 per cent in short term debt (liquid funds); and gold: 20 per cent. While experts favor the SIP route for investment in equities, VIP is recommended for gold. Lump sum amounts can be invested in debt funds, they say.
Sandeep Nautiyal, Senior Vice President at UTI Asset Management Company, says, “As debt funds are performing well these days, there are most inflows in fixed maturity plans (FMPs). While there has been a fall in lump sum investment into equity funds, investors are being advised to take the SIP route for such schemes.”
Falling markets provide opportunity to buy, but this buying should be done sensibly, he adds. As even the liquid funds are generating good returns, we are suggesting 100 per cent investment in liquid funds and from there a regular investment of small amounts to be done into a combination of equity and debt funds via the STP route.”
Redemption not the only way out
Redemption of mutual fund units is not the only way to get liquidity from your investments. These units can be pledged to various private or public sector banks to receive a loan/overdraft facility. The good thing about these loan is that the investor is not required to redeem funds and book a profit (or a loss), especially if he is a long-term unit holder. Even after pledging, he can still enjoy all the dividends and bonus shares, and also get to retain the ownership.
Such loans are given under the head of loan against securities. By giving a simple lien on units to the bank, one can simultaneously continue to enjoy his mutual fund growth and also get tide over his cash crisis. A lien is a hold instruction on the units that are pledged. When someone approaches a financial institution (FI) to get his units pledged, the institution sends a letter to the Registrar and Transfer Agency (R&T) marking a lien in the books; and the R&T blocks the units of the investor and confirm to the FI in writing. They will not redeem the units until the revocation instruction from the FI. The R&T will get a letter from the investor.
Among the ways in which banks offer credit is through an overdraft facility on the investor’s bank account, or a plain-vanilla loan on his investment in mutual funds. An overdraft against MF units asks investors to pay interest only for the amount he utilizes, which could be far lower than his drawing power. But a loan against MF units would ask you to pay the interest for the entire sum borrowed, irrespective of how much is being utilized. It’s usually the private sector banks that give you an overdraft facility, while those in the public sector offer a plain vanilla loan and, in some cases, even an overdraft facility.
Loan feature: In such a case, 40-50 per cent of the NAV is given as credit. Banks also have criteria regarding the minimum and maximum amount of overdraft that could be availed. Usually, the rate of interest varies between 12 per cent and 15 per cent per annum. However, if borrowing is the last resort to fund someone’s need, then overdraft against MF units is preferable to personal loans as it is cheaper by around 100 to 200 basis points in terms of interest cost.
Periodical review: Since the price of the NAV keeps fluctuating, the drawing power of the borrower (40-50 per cent) also gets revised accordingly. The prices may be reviewed weekly or more frequently if required. If the new drawing power is less than the outstanding, the borrower would be required to put in the difference amount or pledge more shares to regularize the account. On the other hand, if the drawing power rises, the limit available to borrower also increases automatically.
Right to sell the units in loan tenure: Manish Jain, Product Head (Loans), Axis Bank, says, “Any person who has taken these kinds of loans has right to sell his/her securities whenever they feel like. It usually happens at times when market sinks. The borrower sells their mutual funds to save money. They may sell their security fully or partly. The amount will be then credited to his/her loan account.”
