Higher Vs Consistent Returns: How to make MFs less risky to attract novice investors?

Mutual Fund (MF) penetration in India is abysmally low with total assets under management (AUM) being just about 11 per cent of the country’s GDP.

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To rope in inexperienced and novice retail investors, it is necessary to generate consistent return on MF investments.

Mutual Fund (MF) penetration in India is abysmally low with total assets under management (AUM) being just about 11 per cent of the country’s GDP, compared to 62 per cent at global level and the highest penetration level of 101 per cent in the US with total AUM surpassing the total GDP of the world’s largest economy. Moreover, most of the MF investors are from major cities, which consist of about 30 per cent of India’s population and the rest 70 per cent people have almost nil exposure to MF investments.

So, to witness an inclusive growth in AUM, a vast number of people from rural areas are to be taken into confidence, who have no knowledge and experience of equity investments and traditionally put their money in fixed deposit (FD), if they invest at all. So, it can’t be expected that they are in a position to tolerate market volatility.

Forget the rural people, most of novice retail investors, who have heard the buzz of equity returns, also don’t want to see the capital invested in negative even for a short period, despite the fact that equities generate superior returns in the long run.

So, to rope in such investors, it is necessary to generate consistent return even if it is not very high return, but marginally higher than FD returns.

“Consistency in returns may be brought in through asset allocation, in which investments are made in both equity and debt in a predetermined ratio. When the ratio gets disturbed, mainly due to fluctuations in equity market, assets are reallocated to get back to the predetermined level. So, when the market is high and chances of corrections are there, funds will be diverted from equity to debt, which would reduce the risk. Similarly, when the markets are low, suppressing the ratio of equity against debt, funds will flow from debt to equity to realign the asset allocation, which would enhance the possibility of gain,” said Financial Coach & Corporate Trainer, Prof. Rahul Ranjan.

“Asset allocation may be done by the investor with the help of a financial advisor. Some funds also have inherent asset allocation mechanism in place, like Balanced Advantage Fund, Equity Savings Fund and Equity Hybrid Fund. Such funds allocate assets to equity, arbitrage and debt,” Ranjan added.

Ranjan further said, “Fund of Funds also work on asset allocation basis. But such funds are not very popular in India as advantage of equity taxation is not there and they also have higher expense ratio.”

Although, some funds have inherent asset allocation mechanism, but managers of such funds also have some limitations in choosing asset classes as they need to follow a benchmark index and invest accordingly. So, market fluctuations in narrow range may be managed without generating negative return, but at the time of high volatility, the funds may follow the benchmark index to negative territory.

As most equity MFs are pure equity funds aimed at generating higher long-term returns for informed and experienced investors, fund managers want to focus on beating the respective benchmark index and want investors to take the help of financial advisors to manage their investment portfolio and do the asset allocations according to their risk appetite.

However, managing their assets is not possible for rural and novice retail investors and they can’t even afford the paid advice of professional financial advisors for their small investments.

Moreover, frequent asset reallocation may result into higher payout of capital gain taxes if done at personal level by investors. On the other hand, tax outgo at investors level would be less, if asset re-balancing is done by fund managers at AMC level.

So, to win the confidence of vast untapped investors, AMCs should think about funds with flexible fund allocation option and a flexible benchmark, which would be comparable to FDs in terms of consistency and return.

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