I know it’s not Monday. But, you have to agree with me that Mutual Fund Monday’s sound so cool. So, let’s get straight to the topic and start with the first article in the series – Mutual Fund Basics 101.
What are Mutual Funds?
Mutual funds are investment vehicles that pool money from many investors for investments in a portfolio of securities. These securities could be stocks, bonds or other money market instruments. Mutual funds are managed by specialists with enough expertise for the investors to trust them with their funds hence, a lot of people participate in mutual funds to benefit from the investment management services of the managers.
Moreover, another reason is that not every individual investor can take advantage of the diversification opportunities from the mutual funds because it requires a huge commitment of capital.
Brief History of Mutual Funds and their Evolution:
The evolution of mutual funds in India has been interesting. It started way back in 1963 with the initiative of the Reserve Bank of India and the government with the formation of Unit Trust of India i.e. UTI. The idea was to encourage saving and investment and participation in the profits & gains accruing from the acquisition, holding, management and disposal of securities.
Over the course of the following years, more banks like SBI, Bank of Baroda and Canbank started to participate in the mutual funds market. The keen interest in the mutual fund industry was more than apparent since the assets under management went from Rs. 6,700 crores in 1988 to Rs. 47,004 crores in 1993.
It was until the inception of SEBI that the private sector shied away from participating in the ever-growing market for mutual funds. The involvement of the private sector tipped the scales in a direction that led to betterment and a new era to the mutual funds market thereby, giving people a wide range of mutual funds to chose from.
Since then, the industry has gone through several crests and troughs but it has always emerged for the better. It even saw foreigners setting up mutual funds in India. There has been no turning back and the industry has since grown. The graph for this industry has been astonishing as depicted by the growth in assets under management from Rs. 12.3 lakh crores in March’16 to Rs. 17.5 lakh crores in March’17.
Why returns are subject to market risks and you have to read the offer documents carefully?
The returns on mutual funds has been a subject of debate, very much like the investments in them. Unlike the returns on shares, that are calculated by the total returns on the shares, the intuition for determining the returns on mutual funds is to compare the NAV or the Net Asset Values of the mutual funds. Now the NAV is determined as the difference of the market value of the assets and liabilities in the funds, on a per share basis.
However, a major point of notice would be that since these are pass-through securities, all the capital appreciation or dividends or any other income from the underlying for that matter, is distributed to the investors, so despite of the funds’ amazing performance it’s NAV could still be the same or even decline. So, a comparison of the NAV might look very dull even though the capital appreciation or the gains distributed to the investors is huge. Hence, the total return would be ideal measure to capture the returns on mutual funds encapsulating the NAV.
Investments in mutual funds has been questioned from a very long time. We could find articles all over the internet on why not to invest in mutual funds and stories from people sharing how they lost all their money by investment in mutual funds.
The primary reason why people don't want to invest in mutual funds is that they're expensive. Apart from the regular expenses, we need to pay for the managers’ fees. Also, the exit isn't easy for a closed-end fund wherein the redemption could be made by selling the shares to the investors in the secondary market where the prices may be significantly different from their NAV’s.
Why everything has to be taxed?
In addition to that, the tax implications scare them. Also, the conservative investors prefer a passively managed portfolio which replicates a certain index to an actively managed one and most mutual funds are actively managed which is what we pay the managers a fee for. Actively managed funds tend to be negative when people give in to the temptation of calculating the returns each time the market moves and make a decision without waiting for a sufficient time frame.
The arguments against investing in mutual funds seem all more vague because if you’re certain about your review and have estimated as to when to exit from the funds correctly, your returns should be satisfactory.
Despite all the arguments against mutual funds investing, people still continue to make money out of investing in mutual funds. As for the scare, what are investments without an element of risk? If an investor wants a return with no risk, they might as well invest in a Treasury Bill.
In the coming weeks, for this series of articles, we will be discussing everything about Mutual Funds, Types of Mutual Funds, AMCs, Asset Caps, their taxation and much more.
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