Wednesday, February 15, 2012
Mutual Funds- A safe way to be in stocks
MUTUAL FUNDS- THE BEST INVESTMENT VEHICLE We always talk about long term investing. However, it seems to have become a buzzword rather than a demonstrated fact. I just came across an interesting study on the industry and this table perhaps illustrates the best example of the role of Mutual Funds in Wealth Creation: Table 1 - Category-wise returns generated by mutual funds across time frames 3 Years(%) 5 Years (%) 7 Years (%) 10 Years (%) Equity Funds 23.80 8.19 18.93 25.46 Balance Funds 23.69 10.02 17.26 20.87 Income Funds 8.86 7.76 7.10 7.41 GILT Funds 4.65 5.99 5.83 7.25 Returns are AUM weighted returns as of November 11, 2011 (From a CRISIL Research Study) Several key takeaways from this useful information: i) These returns are possible only without churn; ii) Patience is important; iii) Risk and Reward go hand in hand, over a period of time; and iv) Equities are the only financial asset class that can help create wealth over the long term. Of course, within mutual funds, there is a wide divergence in the returns. Hence, choosing the right fund becomes important. Luckily for us, we now have sufficient track record in the industry to separate the wheat from chaff. There are good funds that have consistently been in the top five or ten. So long as one sticks to that, these kinds of returns are possible. What is remarkable is the long term performance of balanced funds. They have been showing strong performance. It is perhaps due to their rebalancing act in the face of continuing volatility in the equity market. To my mind, they are surely an asset class to own, within the mutual fund universe. Turning to our markets, they have had a spectacular January in respect of equities. Most mutual funds have delivered better than the indices, in spite of not being fully invested. That surely demonstrates the superiority of diversified equity funds in the longer term. This study also carries out some data on how a ten year SIP in the ‘best’ performing fund has done as opposed to mere passive index investing. For instance, one table shows up that the ‘best’ equity fund delivering a total value of Rs. 4,92.506 over a ten year SIP of Rs.1,000 per month as opposed to an S&P 500 Index return of Rs.2,78,811 . This is a ten percent annualised difference between a mutual fund and the index! And it is over a ten year period and not a one off thing. Now, the next question that one wants to ask is that the example and the data relate to the past. Will the same thing repeat itself? We tend to look at the environment around us and our thoughts get clouded accordingly. If we look back at the past ten years, there have been enough periods of gloom and happiness. So, the setting is kind of similar. The other question, to my mind, is more relevant. Will India Inc’s growth in the next ten years be better or worse than the previous ten years? If the answer is positive, then our equities should deliver good returns. And the other factor to note is that at this point in time, there is no bubble or a valuation concern. So, it is as good a time as any to start off an equity investment plan for the next ten years. So, I would urge those of us who have dark thoughts on equity, to put aside our worries and take the plunge in to a ten year SIP in to diversified equities. From the above table, we will see that Income funds have returned a seven to eight percent kind of return over time. Today, we can lock in our money at higher rates for the next five to ten years at higher rates. The only issue is that of taxation. And another thing about income funds is that the returns have not been straight. Perhaps, now is a good time to park some money in to income funds. As interest rates fall, the values of the assets go up and vice versa. Today, interest rates in India should start to come off. As to the timing, it is unclear, but it can be a reasonable assumption that interest rates are less likely to go up. If we assume or believe that the interest rates should start to come down, this is a good time to invest in to income funds and take the benefit of high coupon returns that the funds have locked in to as well as play the fall in interest rates over the next year or more.