Monday, October 5, 2015

Are mutual funds really transparent?

“Why do you say that mutual funds are transparent? I don’t agree.” Someone asked. ... 

Read on ...

http://epaper.gujaratimidday.com//epaperpdf/gmd/05102015/05102015-md-gm-14.pdf


The English translation of the article is as under:

“Why do you say that mutual funds are transparent? I don’t agree.” Someone asked.
“Well, why do you say so?”
“You know when I buy stocks, I know exactly what price I would get, but when I buy mutual fund units, I do not know at what NAV I will get the units. Where is the transparency?”
Good question. Someone buying something would like to know the price at which the purchase happens. If you only get to know it later, there has to be a very strong reason for the same. Still the investment vehicle that claims to be transparent, does not allow one to know the transaction price in advance.
Let us understand the reason for the same. (The discussion refers to transaction prices in case of open-ended mutual funds only).
First of all, pricing. Mutual fund units are priced once a day for declaration of NAV. So, for all open-ended mutual fund schemes, there is only one transaction price per day. This price is linked to the NAV for the day. This NAV factors the closing prices of all the securities at the end of the day, which are available after the day is over.
While the transaction is reported before a cut-off time, the NAV is calculated hours after the cut-off time. Thus, it is impossible for one to know the NAV at the time of the transaction. The only known price (or the NAV) is that of yesterday.
Why should one not be offered the previous day’s price? That brings us to the second reason, which is the principle of fairness. As we have seen earlier, a mutual fund is a collective investment scheme. There are a large number of investors participating in such a scheme. In an open-ended mutual fund scheme, on any business day, there could be some investors entering, some exiting and some others doing no transaction at all. All the investors must get a fair price and none of these should be able to profit at the cost to others.
All the security prices as of previous day have been factored in calculation of the NAV as of the previous day. Today’s prices are yet to be known.
If someone were to be offered units at yesterday’s price for a transaction done today, the one-day gin (or loss) would go to someone buying today, without even putting any money. In that case, the income investor is likely to watch the prices and do a transaction only if it is beneficial for him (or her). The loser would be the investor who has stayed invested for long.
Thus, the question is not so much about transparency, but about how the NAV is calculated and offering fair prices to all investors.
-        Amit Trivedi

The author runs Karmayog Knowledge Academy. Recently, Amit has authored a book titled “Riding the Roller Coaster – Lessons from Financial Market Cycles We Repeatedly Forget”. The views expressed are his personal opinions.

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