For regular income - equity funds or balanced funds sahi nahi hai ...

Are you seeking regular income from your mutual funds? In that case, please do not look at equity funds or balanced funds. Do not consider regular dividends or even systematic withdrawal from such funds.

Read my article to know more ...

For regular income, equity and balanced funds sahi nahin hai ...

Read the English translation below:

Recent budget proposed by the Finance Minister introduced a tax on dividends from equity-oriented mutual funds. Some mutual fund investors and distributors were upset with this proposal. Some of them had opted for balanced fund seeking monthly dividend. Now these dividends have become taxable. The tax would impact the net amount received in hands.

First of all, let us understand the tax on dividends. This is not the regular income tax that is payable on the income received in hand. However, this is dividend distribution tax, which would be deducted before the dividend is paid out. The dividend that one receives remains tax-free in the hands of the recipient. This means that although the recipient does not have to add the dividend income in the taxable income and calculate the tax on it, it is received AFTER deduction of tax, which would mean that the investor’s returns are reduced.

This is what has upset those who invested in the balanced mutual funds seeking regular income.

We will not discuss about the merit of introducing such a tax. However, the focus of our discussion would be on the choice of equity or balanced funds to seek regular income. Before we launch the discussion, let us also add that now that the dividend is subject to distribution tax, many have started considering regular withdrawal, known as SWP (Systematic Withdrawal Plans) to get regular income. On paper, such a regular withdrawal strategy looks highly tax-efficient in comparison to dividends. This happens since the entire dividend amount is subject to tax, but in the withdrawal case, only the capital gains are taxable and not the capital withdrawn.

The question to consider should be: is it prudent to invest in equity funds or balanced funds for regular income? Very often, people get carried away with the taxes and try to save taxes, forgetting the true nature of the investment category. In the offer document of equity and balanced funds, an important item is called the “investment objective of the scheme”. In all such cases, the investment objective is “to provide long term capital appreciation” and not “to provide regular income”. In fact, even the nature of the asset does not support the ability to pay regular income.

We do not look at liquid funds when the objective is to create wealth. However, liquid funds are ideal when “liquidity” is the prime objective. Exactly in the same manner, if “long term growth” is the objective, equity could be a suitable asset category, but it is not suitable for short periods of time, or for liquidity, or for regular income.

- Amit Trivedi

 

How do you know which scheme you have invested in?

"How do you know where the mutual fund scheme invests our money?"

To understand the answer to this basic question, click here to read my article in today's Mid-day Gujarati, Mumbai edition.

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The English translation is as under:

Recently, after an investment seminar, someone approached me and asked a very basic question: “How do I know if a mutual fund scheme is an equity fund, a balanced fund, a debt fund or a liquid fund?” Well, for someone who has spent more than a decade and a half in mutual fund industry, this was unthinkable. However, the question only reflects that there is still a lot of work required to spread the awareness about a good investment vehicle.

Well, let us come back to the question that the person asked. How does one know what type of a fund it is?

A mutual fund is a portfolio of investments. All of us have a portfolio built by ourselves. We invest some money in bank deposits, some in company deposits, we buy some debentures, we buy some small savings schemes, and we also buy some shares or even a real estate property. We refer to a combination of all these investments together as an investment portfolio.

Similarly, a mutual fund scheme is another portfolio with a few differences. For one, the portfolio referred earlier is self-managed by the investor; whereas the mutual fund portfolio is managed by a professional fund management team. Second difference is huge. While constructing our self-managed portfolios, we normally do not start with some guidelines regarding how we would manage the same. In case of a mutual fund, the scheme’s investment objective, investment style and the investment universe have to be clearly defined in a legal document called the offer document.

It is this offer document that one must refer to in order to understand the details of the scheme. Let us introduce this particular document. An offer document is like a janam-kundli. It is the legal document that binds the fund management company and the fund management team. The fund management team has to manage the scheme in accordance with this document. This is why details like the scheme’s objective, investment style and details of where the money can be invested – are all part of this document. Apart from this basic scheme related details, this document also gives details of the fund management company as well as its promoters, which includes their financial details. This helps one assess the financial and technical strengths of those who manage your money. One can also access information (including the past track record) regarding other schemes managed by the same fund management team. The service and operational details are also a must.

Since the single document was becoming too bulky with too much information, SEBI made an investor friendly change – breaking the document in two parts, viz., Scheme Information and Statement of Additional Information. The former carries details regarding the scheme one is considering, whereas the latter details information regarding the fund management company and other general details.

An investor is required to have read the offer document before investing in the scheme. Please follow this advice as it is always in your benefit to “look before you leap”.

Happy investing

- Amit Trivedi

Get answers to your questions on mutual funds

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Equity investments simplified

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Balanced funds - a good option for a first time investor

My article in Mumbai edition of Gujarati Mid-day today

http://epaper.gujaratimidday.com//epaperpdf/gmd/15122014/15122014-md-gm-11.pdf

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The English translation is as under:

“What are balanced funds? I heard an expert recommending these funds for a conservative investor.” Someone asked. “As the name suggests, such funds should be expected to maintain balance. Am I correct?”

Well, a balanced fund should be understood as a hybrid fund that invests larger portion in equity and some in fixed income securities. The word “balanced” might have been used as in the beginning one would have tried to maintain equal allocation to the two assets, viz., equity and fixed income. However, later on, the allocation changed due to changes in the Income Tax Act (the Act).

As per the Act, a fund is categorized as an equity fund if at least 65% of the fund’s assets are invested in equity shares listed in India. Equity funds enjoy better tax treatment as compared to the other categories. Due to this, the balanced funds invest more than 65% of the fund’s assets in equity shares.

Having said this, these funds are still less risky as compared to the equity funds and hence the same might be a good starting point for a new investor. Let us look at the performance of these funds, especially when the equity markets fell.

We looked at calendar year data of performance of scheme categories – these numbers are added for all schemes in a particular category.

In the last 10 years, there were two calendar years in which equity markets fell: 2008 and 2011.

BSE Sensex fell by more than 52% in 2008 and by more than 24% in 2011. In these two years, the balanced fund category lost 37.14% and 15.41%, respectively as compared to equity multicap funds category, which lost 53.90% and 24.60%, respectively.

As can be seen, the balanced funds lost much less than the pure equity funds in the falling markets. However, in rising markets, equity funds did better than balanced funds in 7 years whereas balanced funds outperformed the equity funds in 1 year.

Thus, we can see that in the rising equity markets, balanced funds do not rise as much as the equity funds, but they provide reasonable protection in falling markets.

It is this characteristic of the balanced funds that make them suitable for a beginner. The equity allocation provides potential of capital appreciation, debt provides cushion against steep fall and classification as equity funds result into better tax-efficiency.

Coming back to the numbers, it is important to note that these funds may also exhibit steep fall in value as can be seen from the performance in the year 2008. Balanced funds as a category fell by as much as 37% during the year. This is quite a steep fall by any standards. Hence, one should not expect these funds to provide complete protection when the markets fall. Even in 2011, when the Sensex fell by roughly 25%, balanced funds lost around 17% for the year.

However, there is a hidden benefit here. When the markets fall, the equity allocation loses value, but the debt allocation would not. This results into the equity allocation being lower than what one started with.

Let us say, the scheme started with Rs. 70 allocation to equity and Rs. 30 to fixed income. After a year, equity had lost 25% and fixed income had earned 9%.

This means, the year-end values of equity and fixed income allocations would be Rs. 52.50 and fixed income allocation would be Rs. 32.70. This means the equity allocation is below 65%. In order to maintain the fund’s status as an equity fund, the equity portion needs to be increased. This can be achieved by selling some part of fixed income component to buy equity. This process is also known as rebalancing.

This rebalancing results into the fund buying equity when the prices are low.

Balanced funds are good for beginners. However, as explained, one must understand the limitations of the same. Some of the biggest limitations would be:

1.     In rising markets, balanced funds may underperform equity funds

2.     In falling markets, the NAV of balanced funds may fall, though not as much as equity funds

3.     Long term returns from balanced funds could be lower than equity funds, if equity markets exhibit a long term rising trend.

Happy investing.

Amit Trivedi

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