Before you invest in Mutual funds, just have a look into this article. Many of us are investing in Mutual Funds by considering various parameters but are those helping to get good returns? The answer is "not sure".
So here are the simplest measures to take care while you are investing in Mutual Funds.
- Don’t avoid equities due to low historical return.
- Never chase high historical returns.
- Don’t be greedy, book profit.
- Don’t invest and forget.
- It’s time for index investing
Don’t avoid equities due to low historical
return:
Though 6.22% Sensex return and 7.54% average mutual fund return
over a decade are disappointing, investors should not avoid equities. Stock
markets, across the globe, don't move at a uniform speed and are known for such
long periods of low, even no returns, To illustrate, the Sensex generated,
zero return between 1992 and 2003. The market, however, generated fabulous
returns between 2003 and 2008, mostly because of the high earnings growth
during this period. Disillusioned investors who stopped their equity investments
in 2003 missed these gains.
The stock market is a slave to corporate earnings and this is getting re-emphasised now. Since low earnings growth holding back the market now, experts believe that the market will start performing once earnings growth picks up.
After a high earnings growth period of 2003-08 and an earnings de-growth in 2008-09, we are in a low ear-rings growth period. Once the expected economic revival happens, we may see 10 % -12% earnings growth in the next 10 years. Though the equity market is still capable of generating reasonable returns in the long term, investors should not ignore the short-term hiccups.
Due to political stability, foreign portfolio investors are investing now through index funds and this has increased the valuation of the Sensex and the Nifty. The current liquidity issue for NBFCs is another worry for the market because they may persist for the next 6-12 months.
The stock market is a slave to corporate earnings and this is getting re-emphasised now. Since low earnings growth holding back the market now, experts believe that the market will start performing once earnings growth picks up.
After a high earnings growth period of 2003-08 and an earnings de-growth in 2008-09, we are in a low ear-rings growth period. Once the expected economic revival happens, we may see 10 % -12% earnings growth in the next 10 years. Though the equity market is still capable of generating reasonable returns in the long term, investors should not ignore the short-term hiccups.
Due to political stability, foreign portfolio investors are investing now through index funds and this has increased the valuation of the Sensex and the Nifty. The current liquidity issue for NBFCs is another worry for the market because they may persist for the next 6-12 months.
Never chase high historical
returns:
Past performance of a scheme does not guarantee similar future
performance. This is a common refrain in the mutual fund industry, Yet,
investors tend to chase historical returns and prefer investing in schemes that
have generated better returns in the past. This strategy rarely works.
To illustrate, schemes that under-performed during the period when the Sensex rose to 20,000 from 10,000 generated an average return of 8.58% during the period it doubled to 40,000. Schemes that outperformed during the 10,000 to 20,000 period generated only 6.74% during the 20,000 to 40,000 period. Similarly, most of the under performers during the 20,000 to 40,000 period were the star per during the 10,000 to 20,000 period.
Most schemes in this list are from the power and infra space, Infra schemes collected a lot of money in 2007 and all of them are in the dumps now—a classic case of investors chasing historical returns and getting burnt in the process. Similarly, some of the laggards of the 10,000 to 20,000 period did well during 20,000 to 40,000 period. So, should investors follow the contra strategy and invest in schemes that did badly in the past? One can't just invest in schemes that did badly.
Read: SYSTEMATIC INVESTMENT PLAN (SIP)
Instead, investors need to see why they underperformed. It is better to avoid an under performing scheme. if the underperformance is due the fund manager or due to fund house's processes. However, if a scheme's underperformance is because a sector or theme, one can take call depending on the changed prospects of those sectors.
For instance, the 10,000 to 20,000 period was mostly led by power and infrastructure; consumption, pharma and technologies were the key under performers. These underperformers turned outperformers during the 20,000 to 40,000 period. So, investors need to bet on sector or themes that are expected to do well and not the ones that did well
To illustrate, schemes that under-performed during the period when the Sensex rose to 20,000 from 10,000 generated an average return of 8.58% during the period it doubled to 40,000. Schemes that outperformed during the 10,000 to 20,000 period generated only 6.74% during the 20,000 to 40,000 period. Similarly, most of the under performers during the 20,000 to 40,000 period were the star per during the 10,000 to 20,000 period.
Most schemes in this list are from the power and infra space, Infra schemes collected a lot of money in 2007 and all of them are in the dumps now—a classic case of investors chasing historical returns and getting burnt in the process. Similarly, some of the laggards of the 10,000 to 20,000 period did well during 20,000 to 40,000 period. So, should investors follow the contra strategy and invest in schemes that did badly in the past? One can't just invest in schemes that did badly.
Read: SYSTEMATIC INVESTMENT PLAN (SIP)
Instead, investors need to see why they underperformed. It is better to avoid an under performing scheme. if the underperformance is due the fund manager or due to fund house's processes. However, if a scheme's underperformance is because a sector or theme, one can take call depending on the changed prospects of those sectors.
For instance, the 10,000 to 20,000 period was mostly led by power and infrastructure; consumption, pharma and technologies were the key under performers. These underperformers turned outperformers during the 20,000 to 40,000 period. So, investors need to bet on sector or themes that are expected to do well and not the ones that did well
Don't be greedy, book profit:
Investors should not get greedy and assume past historical returns
will be replicated in the future too. They should book profit based on expert
advise. This lesson becomes more relevant when fabulous re-turn in the past
have happened over short periods.
For example, the Sensex doubled from 10,000 to 20,000 hi just one year and 10 months generating annualised return of 45.72%, Waiting for such a performance to repeat can be counter productive. So, given the benchmark indices are close to all-time highs, should equity investors book their profit and move out now? Experts advise against it. Investors exit when the show is good. However, there is no need to book profit now because the earnings growth and returns are below average. Time to book profit will come in 2-3 years when the Sensex earnings CAGR is expected to be 20-25%.
For example, the Sensex doubled from 10,000 to 20,000 hi just one year and 10 months generating annualised return of 45.72%, Waiting for such a performance to repeat can be counter productive. So, given the benchmark indices are close to all-time highs, should equity investors book their profit and move out now? Experts advise against it. Investors exit when the show is good. However, there is no need to book profit now because the earnings growth and returns are below average. Time to book profit will come in 2-3 years when the Sensex earnings CAGR is expected to be 20-25%.
Don't invest and forget:
A large number of people invest in new fund offerings (NFOs) or the schemes that are at the
top of the charts at a given time and then forget about them. This is be-cause
of the false assumption that equity funds will inevitably deliver re turns over
the long term. There are several schemes that delivered negative returns over
the past 11-plus years, when the en sex rose to 40,000 from 20,000. Though all schemes generated positive returns over longer periods
(beyond 12 years), their performance has not been uniform. Seven of the 33
schemes beat study (5.000 to 10,000, 10,000 to 20,000 and 20,000 to 40,000).
There are also schemes that were beaten by Sensex in all these three phases, Had funds not done away with several underperforming schemes, the list of under performers would have been much longer. Twenty-two formed at various points in time. This shows that investors should stop searching for the ultimate mutual fund scheme to invest and forget. No one can identify a scheme that will deliver the 'maximum' return.
All investors can do is to get their segment-wise allocation(large, mid- and small-cap ) right and select schemes that match their other requirements - scheme nature, fund manager expertise, fund house philosophy, etc. Even after this, there is no guarantee that all schemes will deliver, so you also need to review you portfolios regularly.
Read Here: Know the basics of Mutual Funds
Most experts suggest an annual port-folio review, but some advise quarterly reviews. No need to make changes quarterly as one quarter is a small time frame to assess performance. But quarterly re-views help investors keep a close watch on qualitative aspects like portfolio changes, fund manager views, etc. If you do not have the expertise to select the right schemes and review your portfolio, you should take help of a professional
There are also schemes that were beaten by Sensex in all these three phases, Had funds not done away with several underperforming schemes, the list of under performers would have been much longer. Twenty-two formed at various points in time. This shows that investors should stop searching for the ultimate mutual fund scheme to invest and forget. No one can identify a scheme that will deliver the 'maximum' return.
All investors can do is to get their segment-wise allocation(large, mid- and small-cap ) right and select schemes that match their other requirements - scheme nature, fund manager expertise, fund house philosophy, etc. Even after this, there is no guarantee that all schemes will deliver, so you also need to review you portfolios regularly.
Read Here: Know the basics of Mutual Funds
Most experts suggest an annual port-folio review, but some advise quarterly reviews. No need to make changes quarterly as one quarter is a small time frame to assess performance. But quarterly re-views help investors keep a close watch on qualitative aspects like portfolio changes, fund manager views, etc. If you do not have the expertise to select the right schemes and review your portfolio, you should take help of a professional
It's time for index investing:
At 7.54%, equity schemes delivered slightly better returns
compared to the Sensex that generated 6.22% during its journey from 20,000 to
40,000. This is in sharp contrast to its huge large outperformance during the
1999 to 2006 period when Sensex moved up from 5,000 to 10,000. During this period
the average mutual fund generated turn of 11.57%.
As the market matures, beating the index with larger margins will become increasingly difficult, especially for large -cap schemes. The chance of large-cap funds beating index funds is very low now. So, it makes sense invest in index 'finds for large-cap allocation. The mid-and small-cap funds, however, still have the ability to outperform the index.
Fund continue to generate alpha in mid-have a mix of index funds for large-caps and actively managed funds for mid and small. Since index revision happens automatically and doesn't involve fund manager risk., index investing is the only option for investors who want to invest and forget. Should investors go for ETFs or open-ended index funds? It depends on investors' convenience For example, you can buy ETFs on an intra-day basis and there's no need to wait for the end of the day NAV. However, you need a demat account and also a broking account to buy ETFs from the market.
Besides, there will be additional expenses whenever you buy or sell ETFs. Since the market price of ETFs can vary, investors need to be careful while buying and selling ETFs. With several fund houses cutting expense ratio for open-ended index lands, the cost of their direct plans is now comparable to that of ETFs. However, index funds are smaller in size compared to ETFs and, therefore, the chance of tracking error (the difference between the index and the fund's performance) will be slightly higher for index funds.
I hope this article supports your plan of investing in Mutual Funds. Please comment with suggestions / queries.
As the market matures, beating the index with larger margins will become increasingly difficult, especially for large -cap schemes. The chance of large-cap funds beating index funds is very low now. So, it makes sense invest in index 'finds for large-cap allocation. The mid-and small-cap funds, however, still have the ability to outperform the index.
Fund continue to generate alpha in mid-have a mix of index funds for large-caps and actively managed funds for mid and small. Since index revision happens automatically and doesn't involve fund manager risk., index investing is the only option for investors who want to invest and forget. Should investors go for ETFs or open-ended index funds? It depends on investors' convenience For example, you can buy ETFs on an intra-day basis and there's no need to wait for the end of the day NAV. However, you need a demat account and also a broking account to buy ETFs from the market.
Besides, there will be additional expenses whenever you buy or sell ETFs. Since the market price of ETFs can vary, investors need to be careful while buying and selling ETFs. With several fund houses cutting expense ratio for open-ended index lands, the cost of their direct plans is now comparable to that of ETFs. However, index funds are smaller in size compared to ETFs and, therefore, the chance of tracking error (the difference between the index and the fund's performance) will be slightly higher for index funds.
I hope this article supports your plan of investing in Mutual Funds. Please comment with suggestions / queries.
Hello, welcome to my blog, Smart Investor. I'm Satyanarayana, a banker & blogger, Investor from Visakha -patnam, India. You can read more about SML here.
No comments:
Post a Comment