Fool-proof measure of a MF's growth
Net asset value (NAV) of a mutual fund is the market value of its assets minus its liabilities
This number is important to investors, because it is from NAV that the price per unit of a fund is calculated.
Funds usually wait until the end of each trading day to recalculate their NAV of each scheme
Simply analysing the NAV is not a fool-proof measure of the fund’s growth.
There are many websites which keep a record of the dividends a fund gives and do all the calculation for you
Be wary of distributors who try to sell you a mutual fund just because its NAV has bloated. He is driven by the greed to earn more commission
It is the oldest selling trick by MF distributors. They say that in the new fund offer, units would be available at Rs 10 and this is as cheap as you can get. Then there are some who ask you to sell off a fund citing that its NAV has become a giant figure and its time to book profits. Not only are both the statements meaningless – but nothing could be farther from the truth. The distributor is simply peddling away wrong information to sell you his funds.
What is NAV?
The net asset value (NAV) of a mutual fund is simply the market value of its assets minus its liabilities. In other words, NAV equals the fund’s worth. If a fund has assets worth Rs 150 crore and is obligated to pay Rs 50 crore for any particular reason (liabilities), it would have a NAV of Rs 100 crore.
This number is important to investors, because it is from NAV that the price per unit of a fund is calculated. The fund house calculates the NAV by dividing the NAV of a fund by the number of outstanding units. In our example, if the fund had one crore units outstanding, the price-per-unit value would be Rs 100 crore divided by one crore, which equals Rs 100.
Since the share prices of stocks in which a scheme has invested keeps changing, the NAVs of funds also constantly keep changing. Funds usually wait until the end of each trading day to recalculate their NAV of each scheme. Open ended funds NAV are published on Amfi (Association of Mutual Funds of India) website by 8 pm everyday. Newspapers publish the same data daily on the stock pages.
The common myths
It is meaningless to say that a mutual fund is cheaper just because it NAV is Rs 10 during the new fund offer. Mutual fund is not an IPO of a stock. A mutual fund is just a pooling of investments to buy a large bunch of shares.
Lets say a fund house collects Rs 100 crore in a new fund offering of a mid cap fund, through one crore investors. If it divides the corpus into 10 crore units then the NAV of the scheme will be Rs 10. But say if it distributes the corpus into 1 crore units – then the NAV will be Rs 100. As an investor whether if you had invested Rs 1000, it is immaterial whether you hold 10 units of Rs 100 or 100 units of Rs 10.
Besides there is nothing called a high NAV. It should be only used to measure returns on a point to point basis at the best. After all it is simply the net market value of your investments divided by the number of units. Fund schemes with low NAVs can give good returns and funds with high NAVs may deliver terrible returns.
Why is NAV useful?
The performance of fund manager can best be judged by calculating the percentage growth of the NAV as compared to a period, say a year, back. But we have to be careful in that simply analysing the NAV is not a good measure of the fund’s growth. Funds are constantly paying out distributions of both capital gains and dividends, which reduce the NAV of the fund and do not reflect any appreciation in the price per unit.
Say a fund’s NAV increased from Rs 10 to Rs 15, but the fund also distributed Rs 5 per unit to all unit holders. The fund hasn’t simply appreciated by 50%, as the NAV would suggest; it has actually appreciated 100% (since if the fund had not given a dividend the NAV would have been Rs 20). So do not mistake a fund’s per-share price based on NAV for the actual earnings of the fund. There are various websites which keep a record of the dividends a fund gives and do all the calculation for you.
Why do MF distributors mislead?
Every time you buy a fund, a distributor gets commission on it. Of course that’s his incentive to sell you funds. But the commission obtained in a new fund offer (NFO) is the highest. Hence he is more inclined to sell you an NFO saying that the units are available at Rs 10. As explained before, this theory is meaningless.
Sellers of funds also get a commission when you change a scheme. So they may tell you that like a share gets overpriced, the MF scheme is overpriced because its NAV has become bloated. The NAV is swelling is simply because the fund manager’s stock calls are in the right direction. When you have entrusted your money with him, leave the decision to book profits with him too.
So the next time, your friendly broker or the banker in a bank next door tells you to buy a mutual fund because its NAV is Rs 10 or sell one because it’s NAV is Rs 100 – you need not change the scheme you are already invested in. Just change the broker.
Stocks and mutual funds have given phenomenal returns over the past few years. For those who had chosen the right equity and balanced funds, returns to the tune of 40 to 60 percent were comfortably assured.
With their growing popularity and greater returns potential, many investors have included a wide array of mutual funds in their portfolio. New funds were often over-subscribed. Even in the intermittent dry spells, investor enthusiasm showed no signs of slowing down.
Randomly selecting funds, without a proper asset allocation strategy, can lead to inefficient diversification. Over-exposure to high risk funds can increase the volatility and affect your returns adversely. Investing in funds with similar objectives fails to diversify your basket. Further, investors must have a clear strategy for buy and sell.
Here are a few strategies to help you manage your funds:
Systematic investment plans
The key to portfolio management is to have a discipline that investors must adhere to. The most successful money managers in the world were successful because they employed a disciplined approach to manage their money. Buy low and sell high is the most common advice for investors. However, markets don't move in predictable patterns. Hence, getting stocks at rock bottom rates and selling at plump price is not as easy as it sounds.
For most new investors, the safest way out is to indulge in regular monthly or quarterly investing, through a systematic investment plan (SIP). A SIP, also called rupee cost averaging, allows investors to build a portfolio gradually even in volatile market conditions.
Selling right
Sometimes, you may need cash to meet other expenses. An investor nearing retirement years may want to shift his investments in equity to other debt instruments. Whatever be the reason, it is essential that you sell your funds at the right time. If the fund's performance is slipping down by the day or the service rendered by the fund house is poor, an investor may decide to opt out of the fund. If your investment goal has changed, it is advisable to sell your fund even if it were a worthy pick.
Buy and hold
The most popular strategy that most investors successfully employ is the buy and hold strategy. Here, the investor sticks to his investment and does not panic in bad times. After a low bearish trend, markets tend to bounce up. Bullish markets are often succeeded by dull patches. Simply buy and hold your investment. Sail through the ups and downs of the market. It is easy to make money when the tides turn upwards in this strategy.
Market timing
This strategy is better left to market experts. Timing the markets is extremely difficult. Though investors know that profits are made when you buy low and sell high, most end up doing just the opposite. This is because investors are emotional beings and panic.
Re-balancing
In simple words, re-balancing means selling some of the funds that did the best to buy some that did the worst. Though it seems to go against logic, proponents of this strategy feel otherwise. They argue that cyclic trend is not limited to markets alone but to individual funds as well.
If you've built a huge portfolio of mutual funds, it is time you manage it efficiently.
Big is bountiful in MF world
Size does matter. Mutual fund schemes with bigger sizes or higher assets under management have posted better returns as compared to those that are smaller in size. In general, there should not be any correlation between size and performance but data shows a different picture.
Equity diversified schemes that are in the range of Rs 1 crore and Rs 200 crore have an average annual return of 4.5% as compared to schemes that are bigger than Rs 1,600 crore, which have an average return of 11%. On a statistical basis, there is a positive correlation of 75% between size and performance. Higher the size, better the performance.
For smaller funds to last in the current market it is important for them to bring in innovative ideas or unique propositions to the customer. If that is not done there is a chance that these funds may face problems in growing their business and also could become takeover targets for some of the larger funds. Devendra Nevgi, CEO and CIO, Quantum Mutual Fund, agrees, “Getting a unique proposition is very important especially for smaller funds. We do not pay commissions to the distributors and prefer to sell our funds directly.
Thus, breaking even for our company is easier as compared to others. As far as size and performance goes, I don’t think that there is any relationship to the same.” The Quantum Long Term Equity has delivered a return of 16% over the past one year and has an asset size of Rs 30 crore.
For different sizes there are different strategies. Smaller funds do tend to take higher risks as compared to bigger funds as these funds are desperate for returns. The top 10 holdings of these funds are very concentrated making these funds more risky than funds that have higher AUMs.
On an average, this figure works out to 30% for small funds and 23% for large funds. Smaller funds tend to take higher risks to make it to the top 10 list in terms of returns. That is probably the reason why we find these small funds giving returns that have got very wide distributions from 26% to -18%.
With larger funds the distribution is between 19% and 2%. In fact, among the truly large funds only the Franklin Templeton India Pharma fund has managed to give negative returns at -3.2%.
Bigger MFs are also in a position to pay higher broking fees if they choose and thus keep on becoming bigger. With size, these funds are also in a position to hire the best talent in the industry and thus these funds perform well. Management fees for MFs is a function of the size of assets managed. Bigger size means higher management fees, thus the highest paid fund managers will always come from funds that have higher assets.
Though there are benefits in investing in large funds, many times the size itself becomes a restriction as these funds find it difficult to churn their portfolios. More than a year ago, a big mutual fund in
Internationally, there are cases where funds gone in for redemption because it became difficult for them to manage the assets. Fidelity Magellan decided to temporarily close shop for new investors on September 1997 as assets touched $50 billion. Incidentally Peter Lynch had managed the same fund for 13 years.
Fund managers go in for the big churn
“Invest for the long term, don’t worry about short-term fluctuations,” is fund managers’ favourite advice to mutual fund (MF) investors who panic at the first signs of market downturn. But most fund managers do not practice what they preach. In other words you may have invested in an equity fund with a three-year investment horizon, only to find that your fund manager has a six-nine month view on the stocks in the portfolio.
According to ETIG estimates, MF manager are rapidly churning portfolios. On an average, they buy stocks and sell it within nine months. In technical terms, such churn is referred to as portfolio turnover ratio. Across the industry, the average turnover ratio of portfolios is around 135%.
What could be the reasons for such high-level portfolio churns?
“Changes in portfolios happen primarily due to target prices being met, relative valuations and change in fundamentals,” says Sivasubramanian KN, portfolio manager-equity, Franklin Templeton.
But that is not always the reason, say market watchers. Often fund managers churn portfolios in order to generate quick returns. And investors are partly to blame for this trend as many of them actively churn their own MF portfolios in favour of better performing schemes. Also a 100% portfolio turnover might not necessarily mean complete change of fund portfolio. It is also possible that fund managers keep a core portfolio that is intended for the long-haul, while he rapidly changes his trading portfolio to make quick bucks from market opportunities.
There is some relief for investors though; portfolio turnover ratios have been falling over the years. For instance, in the first four months of 2007, it was 110%. In 2006, it was higher at 124%. In 2005, it was even higher at 132%. 2004 saw one of the highest portfolio turnover of 160%. One reason for this falling trend could be ‘higher mid-cap’ exposure of equity funds that is yet to see a rally. It is believed that many equity funds with exposure to mid-cap stocks are holding on in the hope of a rally in the near future. In the past one year, mid-cap indices have underperformed large-cap indices.
As per latest portfolio disclosures, many top equity diversified funds had 100% plus portfolio turnover ratios. Reliance Equity had a portfolio turnover of 154%, ICICI Pru Growth —236%, HDFC Equity —158% and Franklin Bluechip — 93%. Sector funds resorted to lesser churn. For instance, for Franklin Pharma it was 32%, Reliance Pharma — 26% and ICICI Pru FMCG — 16%. These ratios were for the half-year ended March 2007.
Equity Portfolio turnover for the MF industry was calculated by taking the lower of 12-month gross purchase or sale divided by the trailing annual equity assets. While the gross purchase and sale figures of MF from capital market was taken from Sebi, equity-based asset figures were sourced from Association of Mutual Funds of India.
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