"All mutual funds are equity funds" - it's just a misconception

Not all mutual funds invest in equity - and still many continue to believe so ...

Read my article on the above topic http://epaper.gujaratimidday.com//epaperpdf/gmd/30032015/30032015-md-gm-12.pdf


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Here is the English translation of the article:

“The mutual funds must be doing well these days! Is this a good time to start investing in mutual funds?” – someone asked the other day.

Such questions are quite common these days. And it has been the same in the past, too. Whenever the equity markets have gone up, many consider that mutual funds must be doing well. On the other hand, during a bear phase in equity market, many think that even the mutual funds are also going through a bear phase. This strong link between mutual funds and equity markets is a big misconception that lots of investors are living with.

In order to address the misconception, we need to understand what a mutual fund really is.

All of us need to manage the surplus money we have saved out of our income. The money must be managed such that we have enough available to provide for our various needs in future. How do we manage our money? There are two major alternatives – do it yourself or get help. Whose help do you get? One professional whose help you may take is a fund manager or the asset management company. An asset management company manages a mutual fund portfolio. this firm has to launch a scheme that would be managed in a particular manner. In order to explain how the scheme would be managed, the asset management company must disclose where the money would be invested (also known as asset allocation) and the style adopted by the managers of the scheme.

Such a disclosure helps investors decide if the scheme can help them in their investment plan. You see, investors start with their own investment plan and then choose mutual fund schemes that are in line with their own objectives.

Seen in this manner, investing through a mutual fund is equivalent of outsourcing the investment management work.

With that, let us understand the options available among the mutual funds, as there are different schemes investing in different investment categories – equity, fixed income, and gold. With that, thee could be different types of schemes – debt funds, equity funds, gold funds, liquid funds as well as hybrid funds, which are a combination of one or more of the above. Different funds serve different purposes. Equity funds offer potential for growth; debt funds offer stability to the investment portfolio; liquid funds offer high liquidity with safety of capital; and gold funds help investors take exposure to gold.

All mutual funds are not equity funds. In fact, mutual fund is a vehicle that helps you invest in a variety of investment options. Understand the scheme and check if it matches with your requirements.

Thus, answering the question asked in the beginning – anytime is a good time to invest, if you have surplus money. Instead of time, one needs to focus on one’s own situation and requirements and there would be an option available from among the mutual fund schemes.

Happy investing!

Amit Trivedi

The author runs Karmayog Knowledge Academy. The views expressed are his personal opinions.

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Benefits of investing in International mutual funds

How do international mutual funds work? Are there reasons why someone should consider these funds? For details, read the article in Mid-day Gujarati ...

Benefits of investing in international mutual funds

The English translation is as under:
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Many parents aspire for foreign education for their kids. This is evident from the number of column centimeters that the education consultants’ advertisements occupy in the newspapers. In such a case, it would be worth considering the cost of such education for the parents of a young kid in high school.

Some time ago, one of the newspaper reports talked about the rise in education costs in the US. The report suggested that between 1985 and 2013, the college fees went up 6 times. This is an annual growth of 6.6%. Considering the inflation in India, this rate of price rise looks small.

However, an Indian parent planning to send the child abroad, must also add the change in the exchange rate between US Dollar and Indian Rupee (Assuming that one is considering sending the child to the US).

On December 1985, the exchange rate was Rs. 12 to a Dollar (Source: Reserve Bank of India). The same was Rs. 65 to a Dollar in 2013. Hence, the cost of education went up 6 times in Dollar terms, and almost 400 times in Rupee terms. This works out to price rise @ 13.25% p.a. over this entire period.

Any major expense in the future must be adjusted for the expected rise in price, if one wants to properly plan.

One of the ways to protect one’s investments against inflation is to invest in assets that have the potential to beat it, viz., equity. However, in the discussion so far, one of the components of this inflation is the change in the exchange rate. In such a case, it might be a good idea to invest in foreign equity funds. If a parent is planning to send the child abroad for higher studies – say ten years from now, one may consider investing in international equity mutual funds. These funds offer protection against potential depreciation in the Indian currency.

Does this mean we are expecting the Indian Rupee to go down against the world currencies? No, we do not know whether Rupee would appreciate or depreciate. It is exactly in such a situation when one is not sure that protection is required.

Today, we have a large number of mutual fund schemes available in the Indian markets that invest in equity markets across various sections of the world market.

Apart from the benefit we highlighted above, these schemes also offer the benefit of diversification to the Indian investors. Even if one does not have a goal to spend money abroad, diversification is a reason enough to consider these funds. If we look at a typical India investor’s portfolio, in most cases, the entire investment is in India – be it stocks, mutual funds, debentures, fixed deposits, post office savings schemes, PPF, real estate – everything is in India.

Although, people are expecting India growth story to continue, one is not sure if the growth path would be smooth or bumpy.

What are the options available today?

Indian investors have two options to invest abroad:

1.     Under the Reserve bank’s liberalized remittance scheme, a certain sum of money can be invested by each income tax assesse every year. However, this process is complicated and hence must be left to those who have substantial sum of money.

2.     Indian mutual funds are allowed to launch schemes that invest in securities abroad. We have today many international equity funds offering exposure to various markets, e.g. US, Europe, Brazil, China (both directly as well as through Hong Kong), emerging markets, Asian equity markets, etc.

There are two types of funds – those that buy securities directly and those that simply buy an existing mutual fund investing in such securities.

All these funds are classified as non-equity funds for the purpose of taxation and hence they are subject to dividend distribution tax, if you opt for dividends and on capital gains tax on redemption.

Consider this as a new alternative and hence tread cautiously. At the same time, it may not be wise to ignore these funds.

Amit Trivedi

The author runs Karmayog Knowledge Academy. The views expressed are his personal opinions.

Disclaimer: This article should not be construed as investment advice.

Is SWP from an equity fund a good idea?

In recent times for retirement planning, traditional instruments are losing its sheen because of inflation. Its time to make use of innovative financial tools like SWP to beat inflation and get regular payments but before using it understand the risks and benefits of SWP. Read on ...

Is SWP from an equity fund a good idea?

Transcript of chat on www.moneycontrol.com

Chat transcript

Understand the pros and cons of investing through mutual funds

Budget 2015 - interesting investment option for the HNIs

Here is the link to my article that appeared in Mid-day, Mumbai edition today.

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The English translation is as under:

28^th February is an important date in the life of many. This day, the Union Finance Minister presents Government of India’s budget to the Parliament. This process is telecast live and it is the most watched parliamentary sessions across the country. This year’s budget carried even more expectations from the people of India since this was the current Government’s first full budget after being elected to power.

People had voted this Government on the growth and anti-corruption agenda and hence the expectations were in line with this.

In this article, we will focus on two of the proposals of the budget, which may have an impact on the way one invests in the fixed income instruments.

1.     Introduction of tax-free bonds infrastructure for funding projects in the rail, road and irrigation sectors.

2.     Abolition of wealth tax, but increase in the surcharge on tax for those earning more than Rs. 1 cr.

Together, these two provisions mean that a wealthy person has lower tax burden but if the wealth generates taxable income, there may not be any net tax saving.

Almost all the income generating, safe investments offer interest income to the investor. This interest income is subject to tax at the nominal rate applicable for the said person. Someone in the highest tax bracket may be subject to highest tax slab for this interest income.

Thus, a wealth person may be best advised to invest such money in either the proposed tax-free infrastructure bonds or in growth plans of fixed income mutual funds.

Fixed income mutual funds invest in fixed income securities and like all other mutual funds, these also pass on the scheme returns as well as risks on to the investor. However, the current provisions of the Income Tax Act offer a huge advantage to investors in fixed income funds.

Any investor directly buying an interest-bearing investment has to pay income tax on the interest income (there are some exceptions e.g. tax-free bonds or PPF, etc.). However, a mutual fund is a tax-exempt entity and hence it does not have to pay tax on the income earned, even if it is in form of interest. This means, if one has chosen the growth option, one gets the benefit of compounding of income BEFORE tax. Over 10 – 15 – 20 years, this can be a huge gain.

At the same time, the mutual fund investor can decide which way one would like to receive the fund’s income – growth (capital appreciation) or dividend – we discussed about these options in detail in one of our earlier articles.

We recommend that the wealthy should consider investing in the growth option of fixed income mutual funds. The fund’s NAV would continue to grow based on the internal earnings of the fund as well as the changes in the market value of investments. If one has a long time horizon (it is fair to assume that one would have a long time horizon for certain investments, since many investors invest their money in PPF (15 years) or the tax-free bonds (10 to 15 years)), the short-term fluctuations in the NAV of debt funds should not be of any concern.

The investor can withdraw any amount of money (subject to balance in the investment folio) whenever one needs it. Such withdrawal may generate capital gains (profit) for the investor. If the withdrawal were after more than three years from the date of investment, the capital gain would be considered as long-term for the purpose of taxation. This means, the profit would be subject to long term capital gain after adjusting for indexation. In most cases, such tax is likely to be very low. Let us look at the calculation of the capital gains by taking an example (all the dates and numbers in this example are only for illustration purposes):

·      Investment of Rs. 10,00,000 in XYS short-term income fund on 1 January, 2011, when the scheme NAV was Rs. 20

o   Hence, the investor was allotted 50,000 units (Rs. 1 lac / Rs. 20)

·      A sum of Rs. 50,000 was withdrawn from this investment folio on 3 March, 2014 when the NAV was Rs. 26

o   The investor redeemed 1923.077 (Rs. 50,000 / Rs. 26)

·      The capital gain was equal to number of units redeemed multiplied by the difference between the prevailing NAV and the purchase price, i.e. 1923.077 units X (Rs. 26 – Rs. 20) = 11,538.46

As one can see, the accounting of the income funds is such that the entire withdrawal is not the taxable income. The capital gain is only a small part of the amount withdrawn. Hence, the investor can take money out of the investment as and when required and still enjoy lower taxes. At the same time, till the time money is not required, the income compounds at before tax rate.

It is worth considering investing in fixed income mutual funds in light of this provision. However, one would recommend an investor to understand the fixed income mutual funds well before investing.

Amit Trivedi

The author runs Karmayog Knowledge Academy. The views expressed are his personal opinions.