Is zero exit load necessarily bad?

Is zero exit load necessarily bad?

Came across this post in one of my favourite blogs - The Parag Parikh blog.

First, read it, before I comment on the same.

From: PPFAS Blog

Sent: Monday, November 22, 2010 6:08 PM

Subject: PPFAS Blog: Zero Exit Load...A boon for speculators

PPFAS Blog

November 22, 2010 4:01 pm

Zero Exit Load...A boon for speculators

Jayant Pai | jayant@ppfas.com
I saw an advertisement on the Value Research website last week. It showed a family exulting in the fact that their child had secured "Zero" marks in the examination. The father was holding a placard stating that "Zero is the new Hero" and the mother was doing a jig. The ad screamed "Zero exit load on two of our flagship funds".
The ad could be considered hilarious, if it were not so depressing. What is the mutual fund trying to communicate? Equity mutual fund managers espouse the cause of long-term investing and the virtues of "time in the market rather than timing the market". Is such a development in sync with this belief? It will only encourage hot money to enter and exit at zero impact cost. It will also prevent the fund manager from taking a long-term view w.r.t. investments. For instance, in the normal course, a fund manager could have allocated 20-25% of the corpus to promising mid-cap and small-cap stocks which were relatively illiquid. That will now be virtually impossible as the sword of untimely redemptions will always be hanging over his/her head. Consequently the manager will play safe either by keeping aside large amounts of cash or investing in liquid stocks even if they are not the best choices at that mom! ent in time.
This appears to be a clear case of the fund's sales team triumphing over the investment team. Such moves to boost assets will be counter-productive in the longer term. Once a fund house becomes notorious as a channel for "hot money", investors with a longer-term outlook shy away from it, as it is well known that sharp ebbs and flows in assets in any scheme hurts the longer term investor more. When SEBI jettisoned the entry-load concept, most of the major fund houses increased the exit load. More than earning income, the objective was to discourage quick entry and exit. Unfortunately, the battle for survival amongst the smaller funds has induced them to opt for this "100% Free" route.
I hope this does not lead to a competitive free-for-all (no pun intended) amongst such funds, who will be competing against one another on price and not on investment performance. This will be detrimental for the whole industry and this time they will not be able to blame the Regulator for the same….

This is one of those rare occasions where I hesitate to agree whole-heartedly with the views expressed in Parag Parikh's blog.

My own thoughts would be, as usual, "It all depends on the context of the individual investor and the context".

• Firstly, those investors who are long-term investors, the mere absence of an exit load would certainly not motivate them to redeem early.
• Secondly, those investors who have a short-term mentality, will, in any case, redeem as and when they're comfortable booking profits. For such investors, "zero exit load" is indeed a boon.
• Thirdly, we now have a situation where more and more fund houses offer a feature to invest / redeem through the stock exchanges. Here again, zero exit loads becomes an attractive proposition.
• Periodically, we have huge volatility in the markets. At such times, an exit load would become a "mental block" potentially preventing investors from redeeming / booking profits despite being conscious of live dangers lurking around the corner, which could put significant downward pressure on the indices. In such times, a "zero exit load" adds significant value.

Having said all the above, there is indeed an element of truth that a "zero exit load" would, indeed, motivate people towards having a short-term orientation.

But then, whoever said that investing and building wealth is an easy task!!!

Regards,

N

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Simple thoughts on "How to choose a Mutual Fund"

Simple thoughts on "How to choose a Mutual Fund"

This is often a perplexing question in the minds of investors, especially beginners.

There are just too many mutual funds around. No point in even trying to understand all of them.

First, let's decide about the broad types:

• Equity Mutual Funds - that invest in shares on your behalf
• Debt Mutual Funds - that invest in Fixed Income products on your behalf
• Hybrid Mutual Funds - that invest in both Equity and Fixed Income products
• Other specialised funds - like those investing in gold, global markets, etc.

The above should give a clue about which ones you wish to consider at this moment in time.

Once you're through with the broad category, how do you choose the specific fund house, scheme, etc.?

Obviously, there are lots of "ranking" websites, magazines, etc. which come up with periodic lists of "top" funds. While many sources are likely to be equally good, ones that I've found useful are ValueResearch Online (valueresearchonline.com) and Economic Times.

Then again, even such "sources" provide only data. How do we find out which ones to choose from among them? I was asked precisely this question by a first-time investor.

Here again, some "don'ts" for the beginners are in order before you decide:

• Don't go for "Fancy" / "Momentum" funds
• Don't choose sector funds till you've become comfortable with investing through mutual funds
• Don't choose a scheme merely because of a fund manager - In India, fund managers come and go and you may not even notice it.
• Don't go merely / solely by schemes which have done extremely well in the recent past. (Even a reputed source of information like "Economic Times" has published on occasions "Top-5 ELSS Funds based on the last week's performance". Wonder what value that would offer, considering that ELSS funds (Equity Linked Savings Schemes) have a lock-in period of 3 years and one week's performance is of zilch value.
• Don't choose Fund Houses which have a track record of "Getting caught with SEBI" for all kinds of wrong reasons, Fund Houses which are too new (less than a minimum of 2 years), Fund Houses which are "too small" in terms of "Assets under management", etc.

Now for the actual inputs on how to choose:

• Identify the top 12-15 funds / schemes in your chosen category from a couple of sources like valueresearchonline, moneycontrol, Economic Times, etc.
• From these, eliminate those schemes which were launched within the last 2-3 years - You need a track record of reliable performance.
• Eliminate schemes from fund houses that are "too new" or from fund houses which you don't rely - for whatever reason.
• Look at the "relative returns vis-a-vis their benchmark indices" over a longer period of 3 years or more in case of equity funds and over a shorter time span of the last 6 months in case of debt funds (especially liquid funds).
• In case of Equity Funds, a further refinement could be to look at the 3-5 year performance of this scheme from Year 3 or 4 onwards from the date of the initial launch of the scheme. (Logic: In the first couple of years, there could be a positive bias due to "Extra" Fund manager attention. Or there could be a negative bias due to a smaller overall fund size, skewing the returns. By year 3 or 4, the scheme would have become a seasoned war horse and you will know the credentials better.)
• By this time, you'll typically be left with a maximum of 4-5 schemes.
• Actually, you can choose virtually any of these 4-5 schemes. Unless you are talking about very large sums of money (as a percentage of your investment portfolio or net worth), it is advisable to invest in a maximm of 2-3 schemes among the 4-5 schemes so identified. If you're investing in equity funds, it is often preferable to park the same in a liquid fund and go in for a "Systematic Transfer Plan" so that you don't end up "Timing the market"

Happy investing!

Regards,

N

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Commissions pocketed by Insurance / Mutual Fund Agents

Commissions pocketed by Insurance / Mutual Fund Agents

Some interesting info from one of my favourite blogs - Jagoinvestor.com - To avoid any unintended misunderstanding regarding plagiarism, I'm straightaway sending you to the original links!

All about commissions earned by

1. Insurance Agents
2. Mutual Fund Agents

(Source: Jagoinvestor.com - Do keep visiting their blog from time to time. Lots of useful gems!)

Interesting, to say the least. Shocking, if you have been thinking that you're hardly paying anything to these guys. Just imagine the actual service that you ought to be demanding from these blokes!

Regards,

N

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World Thrift Day - Why ALL of us Ought to invest in Equity

World Thrift Day - Why ALL of us Ought to invest in Equity

Dear Friends,

Wishing you all a very happy "WORLD THRIFT DAY" - Apparently, it is celebrated on October 30th!

To me, every day is a Thrift Day.

On this occasion, I'd like to make a preposterous suggestion: All of us MUST invest in Equity (either directly or through mutual funds - at least through Nifty BEES). Many may be aghast at this suggestion, saying that Equity is not appropriate for anyone who can't afford to take a risk.

However, I differ.

Take a look at the following table:

Reason as to why you must remain exposed to Equity!	Initial Amount Invested	Annual Return	No. of Years	Final Value of Investment
Even if the initial investment is half, if annual returns are much better, the final value will be much bigger over a long period of time. Moral of the story: Invest at least part of the amount in Equity to ensure higher returns over a period of time.	50,000	1.14	10	185,361
	100,000	1.08	10	215,892
	50,000	1.14	15	356,897
	100,000	1.08	15	317,217
	50,000	1.14	20	687,174
	100,000	1.08	20	466,096

You'll notice that:

• I've just assumed a one-time investment and have done the calculations for two different sums of initial investments - 50K & 100K.
• Obviously, I've assumed that the guy investing 50K chooses to invest in Equity while the guy investing 100K has chosen debt instruments like fixed deposits
• I've assumed a relatively ordinary level of 14% per annum returns for Equity, whereas many mutual funds have given far superior returns.
• I've assumed truly long-term time horizons.

You'll further notice that beyond 15 years, the guy who initially invested just half the sum initially actually outperforms the other guy.

That's the power of a combination of:

• Long time horizon,
• Compounding and
• Equity investing

If the above results are achieved with just a one-time investment, just imagine what you can achieve with a recurring investment in Equity with a good chunk of your disposable surplus savings!

Happy investing. May all of you grow immensely rich and wealthy beyond your wildest dreams!

Regards,

N

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Fw: Why you MUST prefer the Dividend Option while investing in Mutual Funds

Why you MUST prefer the Dividend Option while investing in Mutual Funds

Most investment experts tend to recommend the Growth option while investing in mutual funds, except for those who "supposedly need" periodical inflow of money in their system. I'm yet to meet any individual who can't find any use for any periodic inflow of money into one's system.

However, I differ from these self-proclaimed experts. I wish to affirm that the Dividend Option is Always superior to the Growth Option while investing in Equity mutual funds.

Let me talk with numbers and delve right away into the topic:

Initial Investment of Rs. 10000
Date	Assumed Sensex level	NAV - Growth Option	No. of Units Bought / Held	Present Value	NAV - Dividend Option	No. of Units Bought / Held	Present Value of Units Held	Dividend Received per unit	Cumulative Dividend Received	Total Present Value
01-01-10	16000	10.0000	1000	10,000	10.0000	1000	10,000.00	0	0	10,000
01-04-10	17500	10.9375	1000	10,938	10.4375	1000	10,437.50	0.5	500	10,938
01-07-10	16800	10.5000	1000	10,500	10.0200	1000	10,020.00	0	500	10,520
01-10-10	18000	11.2500	1000	11,250	10.2357	1000	10,235.71	0.5	1,000	11,236
01-01-11	17400	10.8750	1000	10,875	9.8945	1000	9,894.52	0	1,000	10,895
01-04-11	19000	11.8750	1000	11,875	10.3044	1000	10,304.37	0.5	1,500	11,804
01-07-11	17600	11.0000	1000	11,000	9.5451	1000	9,545.10	0	1,500	11,045
01-10-11	21000	13.1250	1000	13,125	10.3890	1000	10,389.04	1	2,500	12,889
01-01-12	18000	11.2500	1000	11,250	8.9049	1000	8,904.89	0	2,500	11,405

As is very visible from the above table, investing in the dividend option is superior in a market with up & down movements for most time periods that one may wish to compare. The growth option is likely to be superior if and only if the market is consistently moving in an upward direction without an exception.

I've kept the above calculations simple so as to make it easy to comprehend.

For the more maths-friendly readers of this blog, I'd recommend that you rework the table with a minor modification:

• Assume that you invest all your cumulative dividends that you receive during a quarter on the first day of every quarter if the NAV is below the NAV prevailing at the end of the previous quarter - And calculate the above returns.
• You'll find that the dividend option is superior virtually for every time period that's worth comparing.
• If you're even more mathematically inclined, you may also wish to rework the calculations by assuming that the dividends are invested in a typical liquid fund for the duration that it remains uninvested!

Secondly, I've just assumed a single one-time investment of Rs. 10,000/= in the above example. Imagine the cumulative impact of all your mutual fund investments that you've made in the past several years!

Talking about investments made in the past several years, do remind me to write about the Power of Compounding in one of my future posts. I'd love to write about it at least once a year without fail.

Regards,

N

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Why individuals have an edge over Fund managers - Prisoners' Dilemma

Why individuals have an edge over Fund managers - Prisoners' Dilemma

For your benefit, let me explain the old but eternally relevant concept of "Prisoners' Dilemma":

Imagine that you and another armed man have been arrested and charged with jointly carrying out a robbery. The two of you are being held and questioned separately, with no means of communicating. You know that, if you both confess, each of you will get ten years in jail, whereas if you both deny the crime you will be charged only with the lesser offense of gun possession, which carries a sentence of just three years in jail. The best scenario for you is if you confess and your partner doesn't: you'll be rewarded for your betrayal by being released, and he'll get a sentence of fifteen years. The worst scenario, accordingly, is if you keep quiet and he confesses.

What should you do? The optimal joint result would require the two of you to keep quiet, so that you both got a light sentence, amounting to a combined six years of jail time. Any other strategy means more collective jail time. But you know that you're risking the maximum penalty if you keep quiet, because your partner could seize a chance for freedom and betray you. And you know that your partner is bound to be making the same calculation. Hence, the rational strategy, for both of you, is to confess, and serve ten years in jail. In the language of game theory, confessing is a "dominant strategy," even though it leads to a disastrous outcome.

If we extend the analogy to Fund managers of mutual funds, we'll comprehend their compulsions:

• Logically speaking, investors like consistent, long-term outperformance vis-a-vis peers and the benchmark indices
• However, magazines, newspapers, business channels tend to publish comparive performance data on a weekly, monthly, quarterly basis. This creates a lot of "noise"
• Fund managers need to be evaluated for determining their increments, bonuses, promotions at least once every six months - this would again involve comparing their relative performance over short durations of time such as a quarter or six months.
• Hence, fund managers are forced to think of an investment horizon of less than six months, even while advocating a long-term view for investors
• This results in a peculiar situation where:
• If the market is overheated according to the fund manager, he may be fully aware that any minor negative trigger can cause a significant downfall. However, he'll be equally conscious that if he is in cash and the other fund houses stay invested and there is no negative trigger for a couple of months or thereabouts, markets are likely to continue to rise with irrational exuberance for quite some time. If your fund manager wants his increments, bonuses (and even his job), he is forced to go against his own better judgement and remain invested in the market - with the hope and prayer that he'll be successful in bailing out at the very peak
• If there is a savage bear market, the fund manager may be aware of huge upside potential over a longer time horizon. Many scrips will be available at mouth-watering levels. However, if he invests and the market continues to tank  and other fund managers remain in cash, he'll underperform his peers in the forthcoming quarter. And in bearish times, he can ill-afford - He may be out of a job before he can say "Long-term".

If you're an individual investor, you must be conscious of these compulsions of typical fund managers before investing in mutual funds.

Mutual funds will be relevant for you if and only if:

1. If you lack the skills or
2. Can't afford the time or
3. Don't have an inclination

to study and invest directly in the markets.

Regards,

N

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Investing in other Emerging Economies

Investing in other Emerging Economies

Financial Experts have often advocated the merits of diversification across not only asset classes, but also across geographies.

However, it is never too easy for a small investor, however well-informed, to go around investing in shares of other countries, though he/she may well be conscious that it is worth taking an exposure to the huge growth prospects of companies based in China, Brazil, Russia, East European countries, Africa, etc.

We have literally thousands of mutual funds offering "so-called" diversification. However, we don't have too many schemes with a focussed play on specific geographies. Recently a fund house has launched a "China fund", which is probably worth exploring. However, it is a fund of funds, and the returns after taking into account expenses and taxes remains an unknown quanitity.

My own suggestion to the smarter fund houses:

1. Launch country-specific mutual fund schemes investing across market-caps in those specific geographies - DIRECTLY in shares of companies listed in those countries.
2. Appoint a small team of fund managers who are experts in those countries, but with an experience of not more than 5-6 years. My own guess is that this can't be too costly.
3. Offer these schemes as "Exchange Traded Funds", duly listed on BSE / NSE - This will provide liquidity to the retail investor while making the AUM relatively less volatile. This will also provide the added tax benefit due to applicability of STT.
4. Offer only a "Dividend Payout Option" - Follow a policy of taking out money off the table whenever you're sitting on profits beyond a cut-off level. This will probably mititgate the risk of entering a relatively unknown market to a certain extent.

The above suggestion would be of immense value to the retail investors and also add to the AUM kitty of the fund house considerably.

Let's see which fund house takes up my suggestion first!!!

Regards,

N

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Investment Advice - Especially for parents with young children

Investment Advice - Especially for parents with young children

Identify a suitable Equity MF (Nifty BEES would be a good idea) and start putting at least a token amount of 100-500 per month in the names of every child below the age of 21 regularly (dividend payout option) - Make it a compulsory stuff for the next few years - till the child reaches the age of 21. The results (due to the power of compounding) will be amazing by the time they reach college. Don't bother about clubbing of income because income will arise only if the MF is sold. Which, ideally, you should not do at all!

Analyse the likely result using an Excel Sheet to find out the likely cumulative amount available at the age of 21, assuming annual returns of 12, 15, 18%. You'll be zapped by the result.

By the way, the above idea is likely to be equally relevant even for adults who are planning to add a "surprise bonus" for their twilight years!

And, those of you who think that the "Growth option" in mutual funds would be a better idea, please ask me why I'm dead against the same. That'll be a good topic for another post on this blog.

Regards,

N

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Don't Pay Entry Loads while investing in Equity Mutual Funds

Don't Pay Entry Loads while investing in Equity Mutual Funds

SEBI has recently enabled us to avoid paying entry loads while investing in Equity Mutual Funds. However, I still find that lots of our friends continue to invest through distributors (and hence pay a hefty entry load) instead of investing directly - Please read this link to find out the benefits of not paying an entry load:

• http://in.rediff.com/getahead/2008/may/28sanjiv.htm

So far as choosing an apt fund for you (which is supposed to be the only reason besides "convenience" why you invest to MF distributors), all you need to do is visit websites like valueresearchonline.com to figure out the answers to all your queries!

Every penny saved is a pound saved, over a period of time!

Regards,

N

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