Mutual Funds: Diversified equity funds suitable for investment horizon of five years

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Published: June 30, 2015 12:02:15 AM

The option of investment via SIPs is available for balanced funds. Most AMCs offer the top-up option for SIPs.

Do balanced funds provide the SIP option? Can I step up the amount every year?
— Hemant Sharma
Yes, the option of investment via SIPs is available for balanced funds. Most AMCs offer the top-up option for SIPs.

Do large- and mid-cap funds perform better in the long run, or should I look at diversified equity funds for a five-year investment horizon?
— Akash Rao

Large-cap funds, as the name suggests, invest primarily in large-cap stocks (typically, 80-85%) with some funds also investing a small portion (10-15%) in mid caps. Mid-cap funds invest primarily in small- & mid-cap stocks (at least 65-70%) while the remainder could be in large caps.

Mid-cap funds have the potential to generate higher returns over large-cap funds in the long term, albeit with higher volatility, and are suited for an investment horizon of 7-10 years.

Diversified equity funds typically invest 50-65% in large caps and the remainder in mid-cap stocks. Therefore, their return potential and volatility in returns lie somewhere between large-cap and mid-cap funds. For a time horizon of five years, diversified equity or large-cap funds would be suitable.

Is there any way to find out if my fund house is charging me more than what they do with others?
— Sanjay Kumar

Up to December 2012, fund houses had the option of offering multiple plans of the same scheme with different expense ratios or charges. Typically, plans with lower expense ratios required higher minimum investment and were positioned for institutional investors. Plans with higher expense ratios, on the other hand, were available for retail investors with lower minimum investment.

In September 2012, Sebi disallowed AMCs from offering multiple plans with different expense ratios. Instead, it directed them to offer only two plans — namely a direct plan, with a lower expense ratio, which any investor can invest directly with the AMC; and a regular plan with a higher expense ratio for all categories of investors available through a distributor.

With some debt funds giving returns similar to bank FDs, does it make sense to stay invested in them, considering the tax implications?
— Shubham Bose

Recent changes in tax norms have brought debt MFs on a par with fixed deposits and other debt instruments in terms of taxation for a horizon of less than three years. For an investment horizon of three years and above, capital gains from debt MFs are taxed at 20% with indexation benefit, making them attractive from a taxation perspective vis-a-vis FDs, particularly for an investor in the highest tax bracket.

Debt funds can be broadly categorized into four parts  — liquid & ultra short-term funds, short-term funds, long-term gilt & income funds and fixed maturity plans (FMPs). Liquid & ultra short-term funds would typically generate returns in line with short-term interest rates like those available on FDs and are suited for an investment horizon of up to 12 months.

Short-term funds invest in debt instruments with maturities in the range of 1 to 3 years with varied credit quality generating returns, primarily from accruals or coupons, and have the potential to give returns higher than FDs.

These are suited for a horizon of 12-36 months.

ST funds, over the last three years, have generated annualised pre-tax returns of 8-10%.

Long-term gilt & income funds typically invest in medium-to-long-dated debt instruments with the objective of generating capital appreciation from a fall in interest rates along with accrual income.

These are suited for an environment of falling interest rates and have the potential to generate superior returns vs FDs in such an environment.

They are suited for a horizon of 2-3 years. LT gilt funds have generated annualised returns in the range of
8.5-10.5% over the last three years. FMPs typically invest in good rated (AAA & AA rated) corporate debt
instruments with tenures matching that of the fund.

Depending on the mix of credit quality of the portfolio, the gross yields (pre-expenses & pre-tax) of FMPs would be either close to that of bank fixed deposits or marginally higher. On a post-tax basis, returns form FMPs would tend to be superior to FDs over a three-year-plus horizon.

The writer is director, Investment Advisory, Morningstar Investment Adviser (India)

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