Understanding exit loads in mutual funds

What is an exit load? How does it affect an investment's returns?

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The English translation of the article is as under:

Exit load

What is exit load?

Certain mutual fund schemes carry an exit load. This is the charge levied when an investor exits the fund scheme, or redeems the money. However, this charge is levied if the exit is made before a certain pre-defined time period. If the investor stays beyond this period, there is no exit load. Let us look at some examples. Various mutual fund schemes may have exit load structures like this:

(1) 1% exit load if redeemed before completing 1 year; Nil thereafter.

(2) 1% exit load if redeemed before completing 1 year; 0.5% exit load if redeemed after completing 1 year but before completing 2 years; Nil thereafter

(3) 0.5% exit load if redeemed before completing 6 months; Nil thereafter

(The above are only some examples. You may check the exit load applicable in the scheme of your choice.)

Which schemes have exit load?

Close-ended funds and ETFs do not have exit loads. Any open-ended mutual fund scheme can have an exit load. However, normally, liquid funds do not have it. Whereas all other schemes may have exit load, the same is not necessary. There are many equity and debt mutual funds that do not have any exit loads. It is also important to keep in mind that the same scheme may have different exit load structure at different points in time.

Though the exit load may be different at different times for the same scheme, in case of any investment the applicable exit load would be the one that was prevailing at the time of investment and not at the time of redemption.

In case of SIP too, the applicable exit load would be the one that were prevailing at the time of each of the SIP installments and thus, different installments may have different exit loads applicable.

How does this exit load work?

The exit load is charged by adjusting the redemption amount for the same. The amount payable to the investor would be less to the extent of the exit load. Let us see that with a calculation:

Let us assume that the exit load is 1%; NAV at the time of redemption is Rs. 20; the balance in the folio is 25,000 units and the investor has opted for redemption of all units..

In that case, the redemption price = NAV X (1 – exit load)

Redemption price = Rs. 20 X (1 – 1%) = Rs. 20 X (0.99) = Rs. 19.80

Amount received on redemption = no. of units X redemption price

= 25,000 X Rs. 19.80

= Rs. 4,95,000

Consider this amount in relation to the money that the investor would have got in the absence of exit load. (Rs. 20 X 25,000 units = Rs. 5,00,000).

Due to the exit load, the investor got Rs. 5,000 less than the value of investments on the day of redemption. This Rs. 5,000 is the exit load or the exit charge paid.

Then again, Rs. 5,000 is 1% of Rs. 5,00,000.

This is how exit load works.

-       Amit Trivedi

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A simple lesson from Warren Buffett for the mutual fund investors

Warren Buffett, arguably the greatest investor the world has ever seen,  wants the companies he invests in to pay him regular dividends, his company, Berkshire Hathaway, does not pay dividends to the shareholders. Can one blame him of employing double standards?

There is an interesting lesson for mutual fund investors here ...

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The English translation is as under:

A simple lesson from Warren Buffett for the mutual fund investors

Warren Buffett is arguably the greatest investor the world has ever seen. Many have studied his investment philosophy and investment strategies in depth. There are many interesting facts about him.

One of the important aspects of his investing philosophy is that he insists that the companies he has invested in should pay dividend to the shareholders whenever possible. The last two words “whenever possible” do not mean “whenever the management thinks right”, the words mean  “whenever the company has surplus available for dividends”. While he wants the companies he invests in to pay him regular dividends, his company, Berkshire Hathaway, does not pay dividends to the shareholders.

Can one blame him of employing double standards? Well, in order to answer this question, we must understand his way of thinking.

According to Warren Buffett, he is one of the best “capital allocators” in the world. He understands how to allocate capital in a manner that the risk of loss is least, whereas there could be reasonable upside, too. That makes him the best investor that he is. Not many are blessed with such capabilities and few know what they are best at.

When he invests in companies, he wants the management to return the excess capital to the shareholders. He knows and strongly believes that between him and the company management, he can invest the money better.

Now let us look at the other side – the investors who have bought shares in Mr. Buffett’s company, Berkshire Hathaway. The firm is an investment company or a holding company that invests in other businesses and generates investment returns through better capital allocation. He does not pay dividends to the shareholders as he believes that the allocation of funds can be better done by him and his partner, Charlie Munger as compared to the shareholders. In fact, if the Berkshire shareholders were better investors, why did they invest their money in an investment company? They also know what Mr. Buffett believes – Mr. Buffett and Mr. Munget are far superior investors than these investors themselves.

So, what is the lesson for investors in mutual funds?

Please understand the difference between investing in a company’s business and giving money to a mutual fund manager to do that job. While in the first case, you are the investor, in the latter case, you are taking professional help for the same. That means, when a company makes profits and has no need for funds for deployment in the business, the management would pay dividend. However, if the fund manager pays dividend, what does the investor do with the same?

If you are anyway going to invest the money somewhere else, why not allow the fund manager to do it?

Think about it.

-       Amit Trivedi

Understanding diversification ...

Mutual fund companies highlight the benefit of diversification. What exactly is it and how does it help one? Let us understand the meaning, benefits and limitations of diversification here ...

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Read the English translation below:

Understanding diversification

Mutual fund companies highlight the benefit of diversification. What exactly is it and how does it help one?

When we invest our money in any investment, there is a lot of work required to study and analyse the same. However, there is still a risk of one’s judgment being wrong. There is a protection available against such errors of judgment. Invest across different companies representing different industries. However, do so only after identifying good companies. This would ensure that even if your judgment is wrong in a few cases, or if things do not turn out as expected, at least some part of your investment portfolio will not disappoint you.

In reality, a well-diversified portfolio tends to protect downside even while allowing one to participate in good part of the upside.

Is there any downside to diversification?

While diversification protects the portfolio from complete erosion, there would always be some part of the same portfolio that would outperform the whole. So if you are stickler for best performance, you are likely to be disappointed, as the whole portfolio cannot beat every single component of itself.

What care should one take while diversifying?

While comparison between the portfolio and one part of the same may make the portfolio look underperforming, it is unfair to do such a comparison. If we go back to the opening paragraph, we discussed that the purpose of diversification is to protect oneself against any unexpected, negative outcome. This means, if no part of your portfolio is delivering a disappointing performance, it is not properly diversified. Imagine, if all the components of your portfolio were rising in value simultaneously, what would happen if the present situation reverses? There is a possibility that in such a situation, the entire portfolio would witness a drastic fall in market value.

The key is to invest across companies, across industries, across asset categories and across geographies. In such a case, the portfolio is most likely to exhibit smooth performance, but as we have already mentioned earlier, it would underperform some part of the market.

- Amit Trivedi

So you haven't received the dividend from your mutual fund?

What happens to the mutual fund dividend that you have not received? Is it possible to get it back even aft6er years have passed? What care should you take to ensure you do not miss out on receiving these payments? Read my article in  Gujarati edition of today's Mid-day to get the answers to these questions.

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What if you did not get your mutual fund dividend?

“I invested in a mutual fund scheme that declared dividend some years ago. I did not get the dividend cheque. May be it was lost in transit. Will I lose that amount? Can I ever get it back?”

Well, as per the process, unclaimed dividends are deposited in an account with Investor Education and Protection Fund (IEPF). However, such transfer of funds happens only after such dividends remain unclaimed for seven years. The logic behind this was simple. If someone has not claimed the dividend for such a long period, there is a very high probability that the claim would never come.

One is not sure, but the logic used here could be in alignment with another law that states that any person missing for more than seven years is declared dead. This was required especially with respect to the distribution of that person’s wealth among the legal heirs.

The dividend rule also could have used the same time period for the purpose of depositing the unclaimed amounts in the IEPF.

However, there is an angle that is often missed out – human behavior. Some of the dividends may not be claimed for long periods purely due to lethargy. What if after a long gap someone realizes that one had not claimed the dividend?

In order to take care of such cases, the Government of India has changed a rule related to the unclaimed dividends. Even after this seven year period is over, one can claim the dividend back from the IEPF. In other terms, with one change in the regulation, the Government has taken a huge step in favour of the investor.

Having said that, it is also the investor’s responsibility to keep track of one’s own hard-earned money. Whether there is a facility to recover the money or not, being unaware of dividends for as long as seven years is not financial prudence.

So what should one do? First of all, one must review the investments on a regular basis – at least once a year. Second, please opt for electronic transfer of all the dividends into your bank accounts. In this way, you would be able to get rid of remembering whether you have received a cheque, deposited it in the bank, whether the cheque validity is over, etc. opting for electronic transfer of funds also removes various other risks related to paper movements, e.g. torn cheques, mutilated cheques, loss of cheque in transit, etc.

So, be careful with your money and take a few small but very important steps.

Measures from mutual funds for safety of investors' money

There are certain measures taken by mutual funds to insure safety of investors' money. Some may appear causing inconvenience, but at the core is the objective of protection from possible fraud. Read on ...

Measures for safety of mutual fund investors

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The English translation of the article is as under:

Another safety feature in mutual funds

Ramesh had shifted to another location due to change of job. Incidentally, the new job also meant that the salary account changed to another bank. In the hurry of shifting to another location, and that too of one’s choice, Rameshthis person wanted to finish all the tasks at the earliest. One of the tasks was to close to bank accounts. He closed his bank account before shifting to the new location.

On reaching the new location, he needed some funds for buying a house to stay as well as for renovation. He opened his mutual fund account statement and checked the balance. He had more than enough money for the requirement. However, in the mutual fund folio, the old bank account was linked and it carried the old address. Ramesh filled in the details in the redemption slip for withdrawal of required amount of money. In the same form, he also filled in the details for change of bank account and change of address.

Three days later, he checked his bank account to see if the money was credited. He was disappointed that it had yet not happened. He called up the call centre of the fund house only to be informed that it would take longer time. Ramesh was angry and asked for the reason for the delay.

The reason was simple, yet Ramesh could not understand. The fund house kept the redemption on hold since there were three simultaneous transactions, viz., redemption from the fund, change of bank details and change of address.

While someone may consider this as an inconvenience, this was done for the safety of the investor’s funds. Let us understand this statement.

When someone wants to fraudulently take out money from someone else’s mutual fund account, the only way to do so is to change the bank account and address. As a normal procedure, the mutual funds send the funds directly to the investor’s bank account or the payment instrument (DD or a pay order) carries the bank account number of the investors as a safety mechanism. Hence, even if someone copies the signature and files for redemption, one cannot take the money out. The intimation of the redemption would also go to the investor’s registered address. That is why a fraudster must change both these along with the redemption request.

How do the fund houses know whether this is a genuine request or a fraud?

That is why they do not process the requests immediately and often they use other means of verification to ensure the money goes only to the investor’s account. That prevents a fraud from happening against the investor.

It is not an inconvenience, but a safety feature.

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Build wealth with mutual funds

How do fund managers manage debt funds

Debt funds, also known as income funds or fixed income funds invest in a mix of government securities, certificates of deposits of banks, corporate debentures, and some other debt and money market securities. These investments are safer than equity securities in that these do not exhibit the price fluctuations as much as stock markets.

While we have talked about various categories of debt funds, some features of these as well as the risks involved. Today, we will discuss how these funds are managed by the fund managers.

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The English translation of the article is as under:

How do fund managers manage debt funds?

Debt funds, also known as income funds or fixed income funds invest in a mix of government securities, certificates of deposits of banks, corporate debentures, and some other debt and money market securities. These investments are safer than equity securities in that these do not exhibit the price fluctuations as much as stock markets.

While we have talked about various categories of debt funds, some features of these as well as the risks involved. Today, we will discuss how these funds are managed by the fund managers.

The function of fund management team is to generate higher returns for the risk taken or to reduce risk for a given level of risk. In other words, they have to reward the investors for the risks taken. The reward should be higher than what an investor would be able to achieve by oneself.

For that purpose, the fund managers need to manage the risks. Or in other words, they need to take calculated risks. In debt funds, there are three major risks that the fund managers manage in order to generate desired fund performance in line with the scheme objective.

These three risks are:

1.     Credit risk:

When you lend money to someone, there is a contract that the principal amount as well as the interest on it would be returned at a pre-agreed time. However, in certain cases, the borrower is not able to honour this commitment. The possibility of such an event is known as credit risk. In other words, the risk can be mentioned as: “what if the principal or interest payments are not received in time or not received at all?”

The companies where such a risk is high, is expected to pay higher interest, else nobody would lend money to them.

The fund managers understand this risk through a careful study of the financial statements and business of the company, as well as an analysis of overall economic situation. With this analysis, they try to find out securities where the future returns could be higher for the suggested risk.

2.     Interest rate risk:

When interest rates in the economy fall, the existing debentures become more attractive, as they carry higher interest rates. Due to this, investors queue up to buy these debentures from the secondary market, which pushes their market prices up. Thus, as interest rates in the economy went down, the prices of existing debentures went up. The opposite of this is also true.

This sensitivity of debentures to changes in interest rates is called “interest rate risk”. Securities with short maturity period are less sensitive as compared to those with longer maturities.

Fund managers may take a view on the possible change in interest rates in the economy and shift the portfolio accordingly. When the rates are expected to rise, the fund managers sell securities with long maturity and buy those with short maturity. When the rates are expected to fall, they do exactly reverse. In this way, they try to reduce the negative impact of rising rates and maximize the impact of falling rates.

3.     Liquidity risk:

When any investor wants to sell a security, there should be a buyer in the secondary market. In the absence of a buyer, there is no liquidity, or one would be required to sell the same security at a discount. At the same time, if a security is known to be illiquid or less liquid, the interest rate is normally high to compensate for this lack of liquidity.

Most mutual fund managers buy illiquid securities only (1) if the scheme’s objective allows it, or (2) the expected redemptions are less than the liquid component of the portfolio. By maintaining proper balance between liquid and illiquid securities, the fund managers are able to get higher interest income as well as provide redemptions without hassles to investors.

So, go ahead and enjoy the fruits of professional management by investing through debt funds.

- Amit Trivedi

Mutual fund expenses - how are these calculated and charged?

How are mutual fund expenses charged? Do I pay both at the time of entry and exit? In such a case, does it not become costly? There are many questions around the fund expenses. Read on for the answers

http://epaper.gujaratimidday.com//epaperpdf/gmd/03072017/03072017-md-gm-12.pdf

The English translation is as under:

Understanding mutual fund expenses

We have already covered the expenses charged for the management of a mutual fund scheme in one of our earlier articles. Mutual fund companies are allowed to levy only two types of charges, viz., (1) exit load – chargeable at the time of investor’s exit from the scheme in certain schemes only if the exit is within a stipulated period of time, and (2) fund expenses – chargeable to meet expenses and payment of fees to various constituents.

We will elaborate on the second in this article today.

There are various constituents working to make the mutual fund run professionally in the best interests of the fund’s investors. These constituents need to be paid their fees for the services provided. This fee is payable through charging each scheme a certain percentage of the fund’s corpus.

These expenses are mentioned in terms of percentage of the scheme’s AUM (Assets Under Management) or the scheme’s corpus. SEBI regulates the maximum expenses that can be charged to the scheme.

These expenses are mentioned as annualized percentages with respect to the scheme’s AUM, but charged on a daily basis such that the scheme’s NAV accounts for the expenses on a daily basis. Let us understand the nature of these expenses with a calculation.

Let us say, a scheme’s corpus is Rs. 1,00,000 and the expenses are 2% p.a. In such a case, the expense charged for the day would be as under:

Expense charged for the day = Scheme’s corpus X fund expenses (% p.a.) / 365

In the example given,

Expense charged for the day = Rs. 1,00,000 X 2 % p.a. / 365

                = Rs. 5.48

If the scheme corpus goes up the next day, a higher amount would be charged for that day. At the same time, if the scheme corpus drops, the expenses charged would be lower. Taking the calculation further, if the scheme’s corpus goes up to, say Rs. 1,10,000 the next day (corpus can change on account of change in the market prices of the securities as well as fresh inflow by investors or redemptions or payment of dividends).

Expense charged for the day = Rs. 1,10,000 X 2 % p.a. / 365

                = Rs. 6.03

On the other hand, if the corpus had falled to Rs. 95,000; the expenses charged would reduce.

Expense charged for the day = Rs. 1,10,000 X 2 % p.a. / 365

                = Rs. 5.21

If someone stayed invested only for three days and then took the money out, the expenses charged would be only for the three days that one stayed invested. Also please note that this is not charged at the time of entry or exit, but on a daily basis. Thus, the expense is charged fairly to all fund investors in proportion to the amount invested as well as their stay with the fund.

Hope this clarifies some doubts that one might have.

Worried about market peaking? 3 things first-time equity MF investors can consider

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A range-bound market near its all-time high make many first time investors worry. Here are three steps that should reduce their anxiety.

What you should know about mutual fund switches

Mutual funds offer a facility called "switch", which allows an investor to shift money from one fund to another within the same fund family. Let us know more about this facility. Click on the link below to read my article about this facility:

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The English translation is as under:

One of the facilities that mutual funds offer is to shift from one scheme to another. This facility is called “switch”. This shift could be for the full balance or even a part of it. This facility is available to only open-ended mutual funds and not in case of close-ended funds. This is because, anyway, one cannot transact with the fund in case of close-ended mutual funds.

Are there any restrictions? How many switches are allowed per year? There are no restrictions in case of open-ended funds, except for applicable exit loads. One can do unlimited number of switches. The only restriction is the pay-in / pay-out cycles in case of fund schemes.

For example, if you redeem from equity funds, the redemption proceeds are paid on a T+2 basis., the applicable NAV in liquid fund would depend on availability of clear funds. Hence, in case of switch into a liquid fund from an equity fund, the switch would be effective only after the redemption from the equity is processed. This would reduce the total number of switches that can be done.

If any exit load is applicable, the same would be charged in case of switches, too.

One big restriction is that switches are allowed only across schemes within one fund house. That means, you are not allowed to switch money from a scheme managed by a fund house into a scheme managed by another fund house.

Why does an investor need this facility?

There are various reasons why an investor may need this facility.

First of all, many investors park their lump sum investment in a liquid fund and then transfer the same regularly into an equity fund over a period. This periodical system of switching is also called STP or Systematic Transfer Plan.

Secondly, some investors take a view on the markets and shift money from one scheme to another. So when equity markets appear costly to an investor, one may want to shift from equity fund to a debt or a liquid fund.

Many switch from equity fund to liquid fund when they want to book profits.

At the same time, some use the facility to switch from liquid fund to equity fund when the equity market appears to be cheap.

Those who believe in the benefits of asset allocation also rebalance the portfolio through the process of switches.

However, this facility is for the benefit of the investors and must be used only when required. It should not be misused.

Finally, please remember that a switch is redemption from one scheme and a simultaneous purchase into another. Hence, the scheme from which one is exiting, there could be applicable taxes.

Both the exit loads and taxes reduce the overall return on investment and hence one must be very careful about these two.

- Amit Trivedi

This or that? Should I buy stocks myself or invest through equity mutual funds?

Often we are faced with choices and on many such occasions, making the choice is too difficult – sometimes we lack the information, at other times the trade-off is too tough and at some other times, we have to choose between some very good offers only because our resources are limited.
In this blog, we will take up some such choices related to money and give our own perspective. While your methodology and decisions may be quite different from us, it is important to have a good framework for making good decisions.

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