Lured by the prospects of higher return and liquidity, investors have been pouring money into mutual funds like never before. However, it is important to know about the mistakes investors typically make.
The last 4 odd years have been witness to a fairly impressive bull run in Indian equities. Even discounting the last few months of pain, investors who have been invested over this period have been rewarded handsomely. Lured by the prospects of higher return and liquidity, investors have been pouring money into mutual funds like never before. The AUM of the entire MF industry went from around Rs 19 trillion in April 2017 to around Rs 23 trillion in April 2018. Another marked development in this period was the substantial increase in individual investors compared to institutions – Individual investors now hold 52% of the industry assets Vs 48% of institutions (The same ratio was 46.5 : 53.5 in favour of institutional investors, just a year back.) Equities being the flavour has been the biggest recipient of this with the share of equity assets moving up to 41.3% from 33.7% last year in April.
This splurge has been euphoric and investors, therefore, need to surely take a step back and assess their investment decisions. Markets have also been fairly conducive and low on volatility over the past 3-4 years (barring the first few months of 2018 which has been volatile, and possibly is what the true character of financial markets is) and therefore investors need to be sanguine about the markets in general.
As the tide recedes, it will be important for investors to follow a disciplined approached to investment decisions. I list down below 5 commonly-made mistakes mutual fund investors typically make:
1. Chasing performance over everything else
One of the easiest ways to choose a mutual fund for an investment is typically to check the past returns and choose the ones that have provided the best returns. Though returns are indeed why investors are in mutual funds, however, from a choice perspective the past returns shouldn’t be the only parameter to choose a fund. The reason for this is that the best of managers can have bad times and even mediocre managers can have a great run purely as a stroke of luck or by investing in high beta stocks that can get hammered in a bad market. It is important to remember what Warren Buffet has to say in this regard “A tiding wave lifts all and only when the tide recedes do we know who is swimming naked.”
Investors should along with the performance also give weightage, amongst others, to (a) consistency i.e How consistent has the fund been over long periods of time, (b) History and pedigree of the fund manager, and (c) Size of the fund – typically both very small corpuses and very large can be detrimental.
Several investors are saddled with holdings in multiple schemes. Some of the reasons that lead to this could be old legacy holdings, caving in to demand of their multiple wealth managers for investing in a new fund / NFO and possibly their own pursuit of being comfortable with multiple schemes.
Investors need to understand that once they invest into a “Diversified Equity Mutual Fund” their holdings are already diversified into many stocks and sectors, and too many schemes come with their own problems of monitoring and tracking. Most equity investors’ financial objectives can be fulfilled with 4-5 equity schemes spread across categories (i.e. Multi Cap/ Large Cap / Mid cap and Small Cap).
3. Abandoning Investments / Commitments Mid Way
A lot of investors, presumably most of them, tend to get into equities looking at past returns and due to which they get caught mostly at the fag end of the market cycle. Since a lot of these return charts show impeccable performance numbers even in shorter periods, they tend to extrapolate and believe that equity and equity funds can be invested for such periods. Equity investors in general should have a minimum time horizon of not less than 3-5 years and should not get deterred by interim losses in their holdings.
4. Mutual Funds are not only about equities
A general conception I have witnessed amongst investors, especially retail and individual investors, is their perception of mutual funds only as an investment vehicle for equity-related instruments. For investors having short to medium term funds and portions of capital they don’t wish to expose to volatility, fixed income mutual funds are a good option. There are many kinds of fixed income funds and investors should do their homework and consult their financial/ investment advisors to understand these products and make an informed decision and match their investment with their investment horizon.
5. Ignoring Costs
In bull markets due to a higher gross return number, investors typically ignore costs as they believe their investment returns could continue to generate the same past performance number that they have seen. However, over long periods all asset classes returns would converge close to the mean. E.g. An investor seeing a 20% past performance might not give too much credence to a 1% extra cost. However, when the same investor has to assess the same 1% cost on a 12% return his concern towards the costs would be higher.
Costs for investors cannot be completely avoided. However, what investors should do is to 1) Understand the commissions or commercial interest the wealth manager or advisor has when they recommend a product (This understanding is more important so as to ensure that the product isn’t being pushed for commercial reasons, 2) Move to a fixed cost engagement with their advisors where their investments are routed through the direct code (where the expenses are lower) while they pay a separate fee to their investment advisor and 3) Over a period of time move a portion of their investments to passively managed instruments like ETF’s ( ETF’s are very low cost investment options that mirror the index. In India apart from the last year or two actively managed funds have outperformed the indices, however over the next few years as the corpuses of these funds grow, they would find it difficult to outperform the index and hence ETF’s might become more mainstream.)
Mutual funds should continue to be a great investment vehicle for years to come. However, it is important that investors and advisors ensure that investors choose the right funds and match the investments with the right horizon so that the experience is pleasant and steady, and the golden goose isn’t killed for short-term rewards.
(By Vivek Banka, Founder and CEO, ALTIORE Capital)