Is your advisor/ agent taking you for a ride?

If you are a mutual fund investor and have a professional advisor to help you, be assured that half the battle is won. However, if you are dealing with someone who is taking an easy way out to convince you to invest, you need to be very careful. As mutual funds in India are evolving, so are different strategies to get the best from them. However, there are certain strategies that many investors have been following for years in spite of the fact that they are completely illogical. If your advisor has been suggesting you to follow these or any of these, it’s time for you to take stock of the situation and act.

Investing in a fund just before the dividend is paid

There are advisors who propagate the theory of investing in an equity fund just before the dividend payment, as a smart strategy. Of course, the major attraction highlighted here is the percentage of dividend as well as the tax-free status of dividend. If your advisor has been telling you that, think before you say yes.

Let us understand how it works. Firstly, if a fund declares 100% dividend, it is paid on the face value i.e. Rs 10, and not on the NAV. Secondly, the NAV of the fund, post dividend payment, gets reduced by the dividend amount. For example, if the NAV of a fund paying 100% dividend is Rs 50 on the record date, the NAV will come down to Rs 40, post dividend payment.

For example, if you invested Rs 1,00,000 in this fund on the record date, you would receive Rs 20,000 as dividend and the value of your investment would come down to Rs 80,000. In other words, you would get a part of your own capital back in the form of dividend and not a gain, as is commonly perceived. At the same time, since the dividend and not the quality of portfolio or the composition of it becomes the main criteria for investment, many a times one ends up investing in a fund that may not merit an investment otherwise. Besides, the very objective of investing in an equity fund i.e. to build capital over time gets defeated.  In case, you decide to re-invest Rs 20,000 in some other fund, you would end up paying an entry load again.

Investing in New Fund Offerings

Many investors have developed a special liking for New Fund Offerings (NFOs), irrespective of what they offer. In fact, there are many agents/distributors who focus mainly on NFOs as it can be more remunerative for them compared to existing funds. Besides, by highlighting “at par NAV”, they find it much easier to convince investors compared to existing funds that have higher NAVs.

Then there are those investors who invest in funds with lower NAV believing that funds with high NAV would give them lesser number of units, which would impact their dividend receipts. The truth, however, is that the dividend percentage is generally decided based on the current NAV, gap between two dividend payments and the philosophy of the fund house with regard to the dividend payment. For example, it will be wrong to assume that two equity funds with the NAV of Rs. 20 and Rs.40 respectively, will declare the same dividend. It is more likely that the fund with the NAV of Rs. 20 may pay Rs. 5 per unit as dividend and the fund with the NAV of Rs.40 may pay Rs. 10 as dividend. In that case, the dividend received in the hands of investors for both the funds will be the same.

If you investment strategy has been influenced by these myths, you must understand that the performance of a scheme largely depends on the quality of the portfolio, its exposure to various industries and segments of the market i.e. large cap, mid-cap and small cap as well as the strategy of the fund manager. Therefore, the logic that investing in a NFO guarantees success is completely unfounded.

It is equally important to know that the price at which you buy units of a scheme i.e. Rs.10 or Rs.50 does not have any bearing on the returns that you can expect from it. Besides, it is essential to understand that a mutual fund launches new schemes to complete its range of products to tap investors with different profiles and investment horizon. Therefore, every new product launched may not suit your requirements and hence you need to analyze the features properly and then take a decision to invest or not to invest. 

However, if a new fund has some compelling features or invests in instruments that you can’t do directly, it definitely makes sense to consider investing. In other words, you should invest in those NFOs that fill the gap in the existing portfolio or widen your investment universe.

Investing in top performing funds

Investing in top performing funds can be quite tempting. After all, who wouldn’t like to have winners in his portfolio? Many advisors also use this as the USP and find it easier to convince investors. However, investing in mutual funds is not about chasing the top performing funds but it is a process wherein one needs to ensure that one selects funds that suit one’s requirements and risk profile.

If you follow a strategy of investing in top performing funds, it might result in over exposure in one segment of the market and/or under exposure in another. As we all know, different segments of the market perform differently in different market conditions. Therefore, depending on the time when you decide to invest, you might end up having over exposure in mid-caps or large caps. For example, if you were to invest in top performing funds at present, you would end up investing pre-dominantly in sector funds.

Though performance should be an important consideration in the selection process, it's critical that you keep performance in perspective. A fund's successful track record can at best be a positive indicator, but not a guarantee that growth will continue at the same rate. In other words, the objective should be to select a fund that is managed well and provides consistent returns. Avoid those funds that are showing very high past returns because of a very big but isolated period.  Clearly, it is important not to depend entirely on the past performance. To be a successful mutual fund investor, it is necessary to have the right mix of funds in the portfolio. The right way is to decide the allocation to each asset class and then decide the funds for each one of them.

- Hemant Rustagi

 The author is CEO, Wiseinvest Advisors Pvt. Ltd. He can be reached at hemant.rustagi@moneycontrol.com

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