Archive for June, 2006

1. Initial Issue Expenses: I had written about this in an earlier post (Mutual Funds must toe the line) and there is now a clarification from SEBI about this. Note that now for all open ended schemes, no initial expenses can be charged. All initial expenses must be adjusted as part of the "entry load". This is fantastic - now they can't con investors with advertisements saying "no entry load", and then adjust the money under initial issue expenses!

Closed ended funds (meaning those where you can't buy more or sell before a certain date) can still charge initial expenses, but not entry load. And these initial expenses must be amortised and removed from the fund if the fund suddenly decides to convert to an open ended fund, or allows any investor to exit prematurely.

2. Trustees to certify NFOs: Take a look at Reliance Mutual Fund. They have Reliance Vision Fund and Reliance Growth fund, both diversified equity funds. Why did they have to release yet ANOTHER fund, called Reliance Equity Fund, with exactly the same goals? And they collected over Rs. 5,000 crore!

SEBI now will ask trustees of mutual funds to certify that a certain NFO is unique and does not have similar goals to any existing fund of the same AMC. Even if an existing fund can be modified slightly to match the new offer, the new offer will be disallowed.

The above two rules will mean a drastic drop in NFOs, but it is great for retail investors and existing investors of funds.

Dividend distribution rules

I had written earlier (Mutual Funds must toe the line) about questionable dividend distribution practises of mutual funds.

SEBI has now mandated, that:
1) Trustees will decide on dividend percentage on the day of their meeting. (Say Day One)
2) The AMC will issue the notice on the immediate next calendar day (Day Two) about the dividend in both a national English newspaper and a regional one.
3) The record date will be exactly FIVE days from the notice date (Day Seven)

Dividend details cannot be communicated before the notice, with anyone.

These changes will ensure that Mutual Funds don't get massive investments just for the sake of a dividend. (which spoils returns for other investors)

Earlier posts about mutual funds:
Introduction to Mutual Funds
Mutual Fund FAQs
Mutual funds must toe the line
ELSS: Not that attractive?

How do we identify which MF is good? What is the right NAV of MF to Buy or Sell? How do you decide whether the NAV will go up or down? What is the basics to identify the right time to put your money or take back?
Tough question. Firstly, do understand that past returns don't guarantee future income, but lack of past returns is probably a negative. Secondly, the fund manager plays a key role in fund performance, so if a fund manager changes, the fund performance will change.

From my perspective, you should choose a fund based on:

a) Is the mutual fund running for over five years? Funds are allowed to amortise initial expenses, upto 6% of the initial cost, for a period of five years. This usually means their returns will be subdued to that extent. Secondly, you can't really analyze fund performance in less than five years, since you need to know how well it does in booms as well as busts.

b) Is the fund manager stable in the fund? If not, don't buy, period.

c) Is the fund overinvested in a specific stock? If you buy a diversified equity fund (like HDFC Equity fund) they must invest in SEVERAL companies, but not more than say 10% in any one stock.

Read this outlook money for a good article on rating MFs.

3. Is there anyway where you can ensure that Principle amount will never be lost? Or is it like stock market? Where there is a possibility of losing your investment?
There are debt funds where the principal investment is never lost. Check out SBI Magnum Income Fund, for instance. Remember, returns are usually between 4 to 8% p.a.

4. What are the best MF's as of today. Where you get the history of MF's to analyse how they have performed in Past? Check out the http://www.mutualfundsindia.com for ranking mutual funds. Some other sites are also given in my Introduction to Mutual Funds.

5. In some articles they talk about Systematic Investment Plan? What is SIP?
SIP: The idea is that you can never time the market. You earn a salary every month. So if you're thinking, "I'll save 5,000 every month and then when the market is low I'll invest", that will almost never happen. You will perhaps hit it when it's going to go lower, or never hit it at all.

An SIP means putting a fixed sum of money every month, regardless of whether the market is up or down. You then cost-average your investment so that in a really rising market or a volatile one, you gain in the long term. Also, remember that most funds reduce the entry load for SIPs to 1%, lower than the 2% you pay for a one timer. Read this personal fn article for more details on SIP.

6. What are risk factors? Risk factors are potential value eroders. Meaning, if you invest in an equity fund, risk of loss is high, so the risk factors will mention that there is a good chance of losing your money - all of it! On the other hand, a debt market fund or a gilt fund has near-zero risk, but there is still a risk that the government will go bankrupt. (VERY VERY rare, but has happened in Lat-Am)

More questions?
Write me a comment.

Let's say you and I had some money, about 1 Lakh rupees each. And we have 8 other friends with the same idea. We all decide that we need to invest this in stocks, but we don't have the time or energy to do research, tracking, buying selling etc. So we hire a "manager" who has the right experience and tell him - look, you can take upto 2.5% of the total value every year as your fees, but you buy shares that will grow over time, and sell when the time is ripe etc.

10 of us have now put in a lakh each, and the total corpus is Rs. 10 Lakh. We decide that we will issue "units" to denote our interest in the fund, so we issue 1 Lakh units at Rs. 10 each. (It's like "tokens" in a casino). So each person gets 10,000 units, corresponding to an investment of Rs. 1 lakh.

The manager, who is quite experienced and informed, makes stock buying decisions based on what we, the investors, decided up front - i.e. only LARGE cap stocks, or only Technology stocks, at least 90% invested (only 10% cash) etc.

As the stock values grow, so does the total corpus value. Let us say the value has gone up to Rs. 15.6 Lakhs in two years. Now we have to pay the fund manager 2.5% every year, let's say that is Rs. 60,000 for two years. So what's left is Rs. 15 lakhs.

So the value of the 1 Lakh "units" is now Rs. 15 Lakhs, meaning each unit is worth Rs. 15 - this is called the "Net Asset Value" or the NAV. Since each of us has 10,000 units, our individual value is Rs. 1.5 lakhs.

Now I decide to take a trip to Singapore and spend Rs. 75,000. So I "sell" half my units at the current NAV, meaning I sell 5000 units at Rs. 15. To give me money, the fund manager sells some stocks, and now the "total corpus" is down to Rs. 14.25 Lakhs.

But that will again grow with time, but I will see lesser growth than you, because I have only 5000 units and you have 10,000.

One day, when the NAV is Rs. 15 per unit, the fund manager decides the market is going to fall. So he sells half the holding. Now there is half the money in stocks and half the money in the bank. So the manager gives us the money in the bank as a "dividend". Let's say he decides to give Rs. 5 per unit as a dividend, for 1 lakh units (ignore my selling bit) - this is termed as a "50%" dividend (since hte initial value of the unit was Rs. 10, and the dividend is Rs. 5. (Your initial value stays the same even after the dividend)

You get Rs. 50,000 as a dividend. But the total corpus has fallen by Rs. 5 lakhs! So the NAV (total corpus divided by no. of units) is going to fall by Rs. 5 per unit. So a dividend for mutual funds is the same as no dividend - you get money, but your fund value goes down.

This is a mutual fund. Now funds can be misused (manager can run away etc.) so the government has regulations for organised mutual funds. They must have a sponsor (usually a bank), a set of trustees (some independent), and an asset management company (AMC) which appoints a fund manager.

Promotion of the fund is done through agents who are recognised by AMFI (association of mutual funds in India). These people get commissions to sell funds, and therefore such funds carry an "entry load", which is usually between 2 to 2.5%. (this is apart from the AMC/Fund manager fee)

How to invest?
Go to your bank, or go to the mutual fund sites online. They will give you forms to fill and you can write a cheque to the fund. The fund will then give you a "holding statement" with a folio number.

Selling (Redemption of units)
You can use your folio number to sell any of your units. Funds release their NAV regularly, sometimes daily. When you sell it will be at a certain day's NAV (usually the day u sell or the day immediately afterwards). And you get the money in two-three days usually.

Some places allow you to invest online - Reliance Mutual Fund does, and HDFC bank's netbanking and ICICI Direct also.

Types of Funds
Note that Mutual Funds can invest in anything - not just stocks. There are those that invest in government bonds, fixed income securities, real estate, indexes, "part debt part equity" etc. Read the offer document of a fund carefully before you invest, and see what the fund will invest in, and how much.

You can also have open ended and closed ended funds. If you can buy anytime and sell anytime, the fund is open ended. Closed ended funds can only be sold at or after a certain date.

Mutual Funds in India:
HDFC Mutual Fund
SBI Mutual Fund
Reliance Mutual Fund
Prudential ICICI
(lots more, these are a few)

Mutual Fund Information
AMFI
MutualFundsIndia.com
MoneyControl Mutual Funds
MyIris

Comments? I hope this helps. Please let me know your thoughts.