Picking a Fund with 15% p.a. in 10 years Or a fund with 25% p.a. in 3 years?

That’s an interesting problem.

Neither 15% nor 25% can be called as bad returns. After all, risk free rates are at 8% or even less. But ofcourse, we are greedy and we prefer higher returns. Isn’t it?

I recently wrote an article for MoneyControl titled:

‘Which fund should you choose: A 15% annual return for 10 years or 25% annual return for 3 years?’

Here is a short snippet of the article…

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To be fair, both 15% and 25% average annual returns are pretty decent.

And let’s accept that the former is more achievable than the latter in the long run. At least for those who know their fund managers aren’t Warren Buffett.

But jokes apart…

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You can read the rest of the article by clicking the link below:

[Click to read] – Pick an MF with 15% p.a. in 10 years Vs an MF with 25% p.a in 3 years

Hope you find the article useful.

Mutual Fund AUM Data – Sept 2018 Quarter

I am planning to regularly track AMC level AUM data going forward. So hopefully, with each iteration, the information and details will increase.

Please do note that the AUM figures are average quarterly figures published by AMFI.

The table below shows AMC-wise average AUM during Jul-Sep 2018 quarter. It also compares these figures over the previous quarter (Mar-Jun 2018) and also with the same-quarter-previous-year (Jul-Sep 2017):

MF AUM India - Growth Sep 2018

Talking of the Top-3, the ICICI Prudential MF continued to lead with an AUM of Rs 3.10 lakh Cr followed by HDFC MF with Rs 3.06 lakh Cr and Aditya Birla Sun Life MF with Rs 2.54 lakh Cr. SBI MF with Rs 2.53 lakh Cr elevated itself to the 4th spot by replacing Reliance MF with Rs 2.40 lakh Cr.

These top 5 AMCs handle about 56.3% of the AUM.

And as expected, more than 95% of the industry AUM is handled by the top 20 AMCs:

MF AUM India - Sep 2018

Here is the list of all the active AMCs in Indian MF space:

  1. ICICI Prudential Asset Mgmt. Company Limited
  2. HDFC Asset Management Company Limited
  3. Aditya Birla Sun Life Asset Management Company Limited
  4. SBI Funds Management Private Limited
  5. Reliance Nippon Life Asset Management Limited
  6. UTI Asset Management Company Ltd.
  7. Kotak Mahindra Asset Management Company Limited
  8. Franklin Templeton Asset Management (India) Private Ltd.
  9. DSP Investment Managers Private Limited
  10. Axis Asset Management Company Ltd.
  11. L&T Investment Management Limited
  12. IDFC Asset Management Company Limited
  13. Tata Asset Management Limited
  14. Sundaram Asset Management Company Limited
  15. Invesco Asset Management (India) Private Limited
  16. DHFL Pramerica Asset Managers Private Limited
  17. Mirae Asset Global Investments (India) Pvt. Ltd.
  18. LIC Mutual Fund Asset Management Limited
  19. Motilal Oswal Asset Management Company Limited
  20. Edelweiss Asset Management Limited
  21. Canara Robeco Asset Management Company Limited
  22. Baroda Pioneer Asset Management Company Limited
  23. JM Financial Asset Management Limited
  24. HSBC Asset Management (India) Private Ltd.
  25. IDBI Asset Management Ltd.
  26. BNP Paribas Asset Management India Private Limited
  27. Indiabulls Asset Management Company Ltd.
  28. Principal Pnb Asset Management Co.Pvt. Ltd.
  29. BOI AXA Investment Managers Private Limited
  30. Union Asset Management Company Private Limited
  31. Mahindra Asset Management Company Pvt. Ltd.
  32. Essel Finance AMC Limited
  33. IL&FS Infra Asset Management Limited
  34. IIFL Asset Management Ltd.
  35. PPFAS Asset Management Pvt. Ltd.
  36. Quantum Asset Management Company Private Limited
  37. IIFCL Asset Management Co. Ltd.
  38. Taurus Asset Management Company Limited
  39. Quant Money Managers Limited
  40. Sahara Asset Management Company Private Limited
  41. Shriram Asset Management Co. Ltd.

How to build your Mutual Fund Portfolio from scratch?

How to build your mutual fund portfolio from scratch

Perfect Mutual Fund Portfolio.

Yes I know that you are looking for exactly that. 😉

But you need to understand that there is no such thing as a ‘perfect mutual fund portfolio’.

There can be numerous reasonably good portfolios, and there’s no one-size-fits-all.

I recently wrote an article for MoneyControl titled ‘How to build your Mutual Fund Portfolio from scratch?’

Here is a short snippet…

Wish to start building your mutual fund portfolio from scratch? Or maybe you already have purchased funds and want to reboot it?

There’s one thing you need to understand that…

You can read rest of the article by clicking the link below:

How to build your Mutual Fund Portfolio from scratch?

 

Do you even have the ‘Right Mutual Funds’ in your portfolio?

 

Best Mutual Fund Portfolio

You have been investing in mutual funds for some time now.

But in last few months, 3 big changes took place. And all those changes can and will impact all mutual fund investors in big ways.

You remember the 3 changes…don’t you?

  • Introduction of Long-Term Capital Gains Tax on equity
  • Changes in existing Mutual Funds attributes due to SEBI’s categorization and rationalization push
  • Shift to TRI for performance benchmarking, which will reduce the so-called over-performance of the funds

I repeat. These are big changes.

Why?

I have already explained it in detail in the post titled MF Investors and 3 Big Changes that will Impact their Portfolio and Returns and here and here. So won’t repeat it here. But if you haven’t read these posts, please do so for your own good.

I am writing this post to bring in front some questions that need to be asked by all mutual fund investors NOW!

This ofcourse is not a comprehensive list.

But it will help you get started in the right direction. So here it is:

  • All future profits from the sale of mutual funds will attract LTCG tax. This means that you need to be careful so as to reduce the impact of this tax and allow more money to remain invested for longer (for compounding). This also means that you should be investing in funds, in which you can ‘ideally’ remain invested for long without much need of selling. So do you have such funds in your portfolio?
  • Have you been investing in flavor-of-the-season funds (or last year’s top equity fund) till now which required you to enter and exit every 1-2 years? If yes, then do you realize that this strategy may not work very well in future due to the impact of LTCG tax on each reshuffling of funds?
  • Do you understand that due to the two above-mentioned points, your portfolio should now be curated strategically to have funds that need comparatively less maintenance and can survive various market scenarios?
  • Do you know how to find such funds that fit into the above criteria (which have become more relevant now than ever before)?
  • After SEBI’s recent categorization & rationalization exercise, several funds have changed their mandates, categories, etc. This means that these funds will not be doing what they were doing till now (atleast to an extent). This also means that the returns delivered by these funds till now may not be possible in future. Do you know if these are the very funds that are still part of your portfolio?
  • Do you understand that not all funds have changed their mandates and categories in the SEBI-pushed rejig? So even though some funds may have to be kicked out of your portfolio, it is possible that many are still good enough to remain invested in. Do you know which funds?
  • Do you understand that some of the funds that you are holding may not remain in line with the asset allocation that you had initially bought them for? For example: Suppose you bought a fund that earlier was a multi-cap fund. But after the re-categorization, it has become a mid-cap fund. So going forward, about 60% of your money would be invested in mid-caps. This is not exactly what you bought the fund for. Isn’t it? Remember you bought it for its multi-cap(ness). So there will be a need to change the funds. Do you know which all of your existing funds have changed so much that they should be exited from?
  • Some of the funds, despite changing name and attributes and categories, may still be inherently doing what they were doing earlier. Therefore, no point exiting such funds. This is all the more important as exiting also means paying exit loads and additional taxes. So do you know which funds you hold are still the same even after getting their new clothes?
  • Do you know that after the change in benchmarking for mutual funds, it will be more difficult for the funds to beat their benchmarks like earlier? Fund managers will now have to work extra hard to deliver benchmark-beating returns. This will be difficult for them to manage on a consistent basis. So do you have funds that have been able to beat new TRI-based benchmarks in past? Do you even understand what I am talking about??
  • Do you understand that the two changes in combination, namely i) using TRI for benchmarking and, ii) limited universe of stocks available for fund managers to invest as per SEBI’s new guidelines, hints to the fact that more and more large-cap funds will find it difficult to beat their benchmarks? This also means that there is a case for investing in index funds for a subset of investors now. Do you realize why this might make sense for you too?

Thought provoking… Isn’t it?

Even I have reviewed my personal mutual fund portfolio in last few months and made changes where necessary.

It goes without saying that proper review of your existing mutual fund portfolio is now more necessary than ever before.

Chances are high that you may want (or have) to weed out unwanted schemes from your mutual fund portfolio as soon as possible.

I understand that you might be worried about exit loads and taxes. But these are short-term pains and frictional costs that must be borne for long-term course correction.

In fact, take it as a forced blessing-in-disguise. You are being forced to think properly about how to build a robust, all-weather mutual fund portfolio that is worth remaining invested in for several years.

So go on… identify funds that should be exited from your portfolio. Find out funds that are worth bringing in to your portfolio based on proper fund selection and above discussed questions.

Also ensure that your final fund portfolio (after all the changes) – maintains proper asset allocation, is reasonably diversified among various caps and fund houses, has funds that can be held for several years, doesn’t have adventurous funds which may cause regret in future, and most importantly is built on common-sense.

This is an opportune time for you to build a mutual fund portfolio wisely and safely and that is well-positioned to create wealth and achieve your financial goals.

3 Big Changes that will impact Mutual Fund Investors

Big Changes in Mutual Fund

Last few months have been very dynamic and interesting for the mutual fund industry.

3 big changes have taken place that are going to impact all mutual fund investors and how they take their investment decisions in future.

If you are a little confused about what these changes are, then let me calm you down.

Maybe you have already heard about them but not understood their impact fully. Or it might have slipped off your mind as the impact may not be immediate or even short term. Nevertheless, I feel that these 3 changes need to be understood by you as long-term mutual fund investors.

So without wasting more time or making it a very long post, I will try to highlight what these changes are.

By the way, I have already written about two of these changes in super detail earlier. I will share the links two those articles shortly.

So what are these changes?

  1. Introduction of Long-Term Capital Gains Tax (LTCG) on equity
  2. Categorization & Rationalization of existing funds
  3. Use of TRI or Total Return Index for benchmarking of funds

If all three seem boring and too technical to you, then please hold on (and don’t close the window).

These are important changes. These are not just administrative changes that will have no impact on you. These three (yes…all three of them) will impact you and have a role to play in how much wealth you will create. So it makes sense to understand these changes.

Please. 🙂

Your money. Your responsibility.

I hope you are still reading.

Let’s get into these changes now…

1) Introduction of Long-Term Capital Gains Tax (LTCG) on equity

Unlike earlier years, your profits (capital gains) from equity after 1 year will now be taxed. So the actual money that you get in hand will be little lesser than what you would have got in a zero-LTCG regime.

But I won’t get into the details about LTCG tax here.

I have already addressed the impact of LTCG tax on long term investors in a super detailed post mentioned below:

Real impact of LTCG tax on long term equity investors

So I strongly recommend you read that post if you haven’t already.

It’s a little long but that should not stop you from reading it as its important. Bookmark it and read it when you have made time for it.

2) Categorization & Rationalization of existing funds

The regulator SEBI has ‘forced’ the fund houses to clean up their acts and make their fund offerings more logical, simpler to understand and more investor-friendly. This also forces the fund houses to be truthful to what they are offering.

This might seem just like a cosmetic change upfront to many. But it isn’t. This is one of the biggest change in Mutual fund space in recent years.

This will directly impact your investments as some of the funds will see big changes in their portfolio. And if you are MF star-rating lover, then please note that this will also impact how much returns some of the earlier 5-star rated and popular but now ‘rationalized’ funds will deliver.

So if you are an existing investor of any of these funds, then you will be impacted. So logically speaking, you should sit up and take notice of this change.

Want more details to understand it?

I have written a huge article on this.

Here is the link to that article:

Real impact of the NEW Categorization & Rationalization of existing mutual funds that YOU have Invested in

Please read it. Like the first one, this too is important even if you don’t feel it is right now.

That brings us to the last one…

3) Use of TRI (Total Return Index) for benchmarking of funds

(I haven’t written about this topic. So I will tackle it here itself in some detail)

This is another important development. It won’t put more money in your pocket directly. But it can help you take better decisions when picking right mutual funds – which in turn can put more money in your pocket eventually. 🙂

I will explain myself in a bit.

The respected regulator SEBI has asked all mutual fund houses to adopt the Total Return Index (TRI) to benchmark their schemes.

According to the regulator (and many others), this is a more appropriate way to measure the performance of such financial products. Here is a link to SEBI’s circular on TRI adoption for benchmarking fund mutual performance – Link

Till now, most equity mutual fund schemes have been benchmarked to the Price Return variant of the Index (PRI).

So what is the difference between this new animal TRI and the old PRI?

When you invest, there are 2 components of the total return you can make from your investments. First is ofcourse capital appreciation, And the second is the dividends from that investment.

If you only consider capital appreciation, then it means you are looking at PRI version. But if dividends are factored in too alongwith the capital appreciation, then that’s TRI – Total Returns.

Naturally, the returns of a total return index will always be higher than that of a price index.

Let’s now come back to the mutual funds.

The MFs receive dividends on the stocks they hold in their portfolios and this dividend is re-invested into the scheme. So ideally, they should compare their performance with Total Returns Index. That would be fair. But as I said earlier, they use PRI or Price-only Index.

How does it change the depiction of fund manager’s ability?

Suppose a Rs 100 invested in a fund becomes Rs 120.

The PRI index (which is generally used) to benchmark has grown itself from 100 to 112 in meantime. So in this case, the outperformance over and above the benchmark is Rs 8 = (Rs 120 – Rs 112).

On the other hand, TRI includes dividends and hence will be higher than PRI. Suppose it is 116. Obviously, the outperformance over and above the benchmark is now reduced to just Rs 4 = (Rs 120 – Rs 116).

Here is a simplistic summary:

Total Return benchmark Indian mutual funds

What has happened and why have fund managers been using PRI till now?

As returns appear lower in case of a PRI, it is easier for a fund to show higher out-performance against it. Read the previous statement again.

So when the fund compares itself with a PRI, it shows a much higher outperformance than it is actually doing (when compared with TRI). 🙂 🙂

PRI doesn’t capture the dividends which are available for the fund. TRI does that.

This gap between the price-only returns and Total-Returns in a way tells that by avoiding the recognition of dividends (in TRI), it actually helps the case of fund managers as they can set a lower bar on the returns that they need to make to ‘outperform’ the benchmark! 🙂

This might seem bad but luckily, SEBI has taken care of this by forcing fund houses to adopt TRI now. I am sure that if SEBI had not pushed the fund houses, most MFs would have continued to use PRI benchmarks. To be fair, few fund houses had already adopted the TRI for benchmarking even before the regulations came. Cheers to them!

I did some number crunching with Nifty50 data of last 10 years (Apr-2008 to Mar-2018).

The Nifty returned 7.87% over this 10-year period, while it’s TRI version returned 9.16% over the same duration.

Now suppose the fund you invested in gave a return of 10% in the same period. If you use PRI, then outperformance is 2.13% whereas if you use TRI, the outperformance over benchmark reduces to just 0.84%.

Nifty Total Return benchmark mutual funds

It is still outperforming the benchmark, but as you might have noticed, the outperformance (or what fund managers take credit for and become celebrities) can go down significantly due to change in benchmarks.

Hence, TRI is more appropriate as a benchmark to compare the performance of mutual fund schemes. And going forward, atleast some of the funds will have a tougher time beating this benchmark – something that they were able to do easily earlier. This pushes fund managers to work harder to generate real alpha (outperformance) and not rely on technical differences between TRI and PRI to artificially bloat their alphas.

But nothing is perfect.

Some people are saying that even the TRI is not perfect.

Why?

Because mutual funds have to keep some liquid cash aside too – for liquidity needs and in search of better opportunities. And the index – which is the benchmark does not have to keep this cash! So if this cash component of the fund is slightly large, then it can drag down the overall performance of the fund. And this reality is not captured by the TRI.

So it seems that the PRI was overstating performance while the TRI is ‘slightly’ understating it when compared to the index. 🙂

This is true to an extent. But I don’t buy the argument completely as cash was held even under the PRI regime. This is nothing new that is introduced in the TRI regime. Isn’t it?

As I said, nothing is perfect. So we really cannot ignore the investor-friendliness of using TRI over PRI for benchmarking.

But it is important to highlight something here:

The use of Total Returns version of the Index for benchmarking has absolutely no impact on the actual returns generated by the mutual funds. It is just done to ensure that fund performance is compared more accurately against a correctly chosen benchmark.

I know what you are thinking.

If this doesn’t impact the actual returns, why should we even be bothered?

There is a need to understand this difference between total return and price return. And it is because when you are picking good mutual funds to invest in, one of the many important criteria is to see how is the fund’s consistency with respect to its benchmark. As since beating the benchmark will be slightly tougher now, this factor will play its role in the proper selection of good mutual funds to invest in for the long term.

Let me remind that beating benchmarks is not the only factor in fund selection. There are several others which are important enough.

Another thing to note here is that changeover to TRI in no way means that fund managers will not beat their benchmarks. It only means that the number of funds beating the same benchmarks will be reduced in years to come. This fact will get a further push as SEBI’s directive to rationalize mutual funds has asked fund houses to just have one fund per category.

On a related note, some people are of the view that since beating benchmarks will be tougher, its best to go for index funds. There is no clear-cut answer here, to be honest.

Index fund is a beautiful product. More so now. But still, good fund managers will continue to do better than those index funds.

But the margin of their outperformance will get reduced to some extent. And as the years progress, the difference (or outperformance) will get reduced on a category basis. I will still not write off active equity funds as I believe that proper fund selection can increase the probability of finding index-beating and proper-benchmark beating funds.

But I agree, that the time for index funds will come soon.

And now more than ever, it’s true that an Index fund may not beat a good fund manager. But it will surely beat a bad one. 🙂

Why is SEBI pushing for so many changes in the Mutual Fund industry?

Many followers of the MF industry (me included) can vouch for the fact that the last few months have been quite eventful for the industry as a whole.

Implementation of LTCG on equity gains by the government, rationalization of schemes and forcing adoption of TRI by SEBI – these are not small developments.

And as far as I can make out, the future will see more announcements of such regulatory measures.

As you might have guessed by now, these are being done to ensure that the industry remains investor-friendly and curb misselling to some extent.

The industry is growing by leaps and bounds and as more and more people are joining the mutual fund bandwagon believing that #MutualFundSahiHai, it is only rightful that the regulator is doing its bit to nudge the industry to clean up and take a moral high ground.

I hope this article that focuses on use of Total Returns Index for benchmarking by mutual funds and other two focusing on tax on LTCG from equity and Categorization & Rationalization of Mutual Funds were able to give you the clarity that you need to have regarding these changes.

For common people, the Mutual funds are the best investment option to create wealth in the long run. And with new changes, it is expected that industry will be better regulated and investors will have the right information to ask the right questions from their fund managers.

Inspite of these 3 changes, nothing changes in how you should go about managing your money. Know yourself and your financial goals. Get yourself a good financial plan that gives you a roadmap to invest properly. And then, stick to the plan and continue monitoring your investments properly. That’s all that is needed.

So happy investing.

If you have any questions pertaining to these developments or want to take professional help in creating a solid financial plan (details here), please contact me.

Are Mutual Fund Star Ratings any Useful?

Mutual fund star ratings

Thousands of people rely on mutual fund star ratings for picking good or best mutual funds to invest in. It’s a popular metric amongst investors and advisors alike.

These stars (ratings) are provided by agencies like Morningstar, Value Research, Money Control, CRISIL, etc. Most of them rate funds on several parameters and come up with a star rating – which ranges from 1-star to 5-stars. Top funds get 5-stars and ones at the bottom get 1-star.

It’s a simple method of comparison for investors and advisors. Naturally for fund houses, it is also a free method of advertisement for their well-rated products. 😉

Most people believe that a 5-star rated fund will perform better than all others. But truth is that… this is not necessary.

So…

Are Mutual Fund Star Ratings really useful?

Before we move on to discuss this important question, let’s understand why these ratings are so popular first.

The number of funds available is overwhelming and unnecessarily large and most people don’t know how to pick the right mutual fund schemes. So they take the easy way out and end up relying on star ratings.

In words of the founder of Morningstar, the star rating system ‘is a way to whittle down a big universe into something more manageable.’

I agree here.

Mutual Fund (star) ratings are designed to help investors quickly identify funds to consider for their investments. For starters, they give investors a quick-and-dirty opinion on the chosen fund within minutes. And this is perfect for our era of time-poverty.

But the problem arises when investors rely solely on these ratings to pick funds.

They treat these stars as a guide to future performance and high star rating to be a definite buy signal.

This is not the right approach. It is plain stupid.

Mutual fund ratings by themselves do not guarantee high returns in the future.

It is not at all necessary that a 4- or 5-star rated fund will always perform better than a 3-star one. But it is generally expected that over a period of time, better rated mutual funds do perform better than lower rated ones. But there are numerous instances where lower rated funds have outperformed higher rated ones.

In this post, I don’t intend to talk negatively about rating agencies. There is nothing wrong with the concept of star ratings. These are based on actual data and solid maths.

The idea instead is to remind investors that they need to look beyond star ratings. Many investors rely blindly on star ratings and have questions like:

  • Should I choose only 5 star rated mutual funds?
  • Should I choose only mutual funds that are either 4 or 5 star rated?
  • Should I switch out of my mutual fund investments every time my fund’s rating is downgraded?

These investors need to wake up and understand that the star ratings are not enough.

But investors alone should not be blamed. Many financial advisors love star rating systems too.

They take this easy route and use star ratings to justify their advice. 🙂 I have seen this being done by many advisors! Even many of you would have experienced it. It’s a cover-your-@$$ type of service… An advisor can say, ‘I’m going to put you in this fund, it’s a 5-star fund,’ …and if something goes wrong the advisor can shunt blame to the rating agency.

🙂

But keeping aside advisors and rating agencies for a while now…

Why you should not blindly depend on ‘Mutual Fund Ratings’?

Ratings do a decent job of accurately analyzing a fund based on its past performance (and few other criterias). But the downside is that this isn’t a good guide to future performance.

You cannot use these ratings to correctly predict future performance. And that is what most people forget.

Remember the standard disclaimer that has become too common for its own good?

“Past performance is no guarantee of future results.”

It is not just a disclaimer. It’s reality!

Most fund rating agencies do suggest that their star ratings are backward-looking assessments. And since past performance is no guarantee of good future performance, one should consider the limitations of these ratings when making investment decisions based on them.

At best, these ratings should be considered as a sort of filtering mechanism when selecting mutual fund(s) to invest in. Both for lumpsum and regular SIP investments.

If necessary, then investors should only use this ratings data as a starting point, combine it with other important factors (consistency, suitability, fund objective, portfolio, expenses, fund manager’s track record and experience, investment process followed, integrity of the fund house, etc.) for shortlisting funds.

My view is that these ratings may not be even a good starting point for research. I prefer taking the data and analyzing it myself.

And think of it, it would be really great if picking funds were as simple as looking at how many stars it has earned. If rating agencies believed in their ratings, they would be running big portfolio funds which would be investing in these high-rated funds. 😉 That is something to ponder about.

And it’s not just me who is being sceptical here. Even Morningstar’s CEO voices similar thoughts here:

  • We recognize and have often acknowledged the limitations of a measure like the star rating that’s based on past performance, but we also believe it can usefully tilt the odds in investors’ favor, when combined with other research and tools.
  • We’ve long described the star rating as a worthwhile starting point for research that can help investors make good decisions, when combined with other research and tools.

I say this again – mutual fund ratings as a concept is fine. But as an investor, you need to focus on more important things.

Instead of looking to invest in all the top rated mutual funds, you first need to ensure whether you got the category of the mutual funds right or not. And that is after you have decided which financial goals you are investing for.

Choosing the highest rated fund in the wrong category can kill your investments and you risk not achieving your financial goals. Being in the ‘Right’ fund in right category is much better than being in the ‘best’ fund of a wrong category.

The ‘best’ mutual funds suited for your real goal-based investing needs may not necessarily be 5-star rated. They may not be category toppers too. Also, a high ranking for a particular fund does not mean that it will be necessarily suitable for each and every investor.

Another issue is that different strategies (fund’s investment strategy) or styles go out of favor and then come back after few years. So if you exit a fund that has dropped in rating due to their particular reasons, chances are that you will miss out when the strategy returns with all guns blazing.

This is something that most people don’t realize when going via ‘I-only-bother-about-fund-rating’ route.

Is it a Mirage?

Recently, a Wall Street Journal (WSJ) article titled The Morningstar Mirage created a lot of drama in the investment fraternity. And the subtitle of the article got straight to the point:

Investors everywhere think a 5-star rating from Morningstar means a mutual fund will be a top performer – it doesn’t. 😉

In the article, WSJ concluded that the top-rated funds attracted a majority of investors’ money (in the US) but most didn’t continue performing at that level. Unsurprisingly, the rating agency in question hit back (link) with its counter-views protecting itself; and in essence claiming that their ratings were not supposed to be predictive and they should be a starting point for investors selecting funds. Their CEO also pitched in with his views (link).

If you go through all the articles related to this particular episode, you will understand that the rating companies also know about the shortcomings of star ratings but they have a business to run. 😉

Let’s talk about the possibility of conflict of interest here.

I am sure most mutual fund rating entities are professionally run. And since most information is in public domain, chances of wrongdoing seem limited.

But who knows… 😉 😉

A fund that is rated well (lots of stars) will attract more investments if fund houses pitch it strategically to advisors and investors. Its easily possible that investors would continue to pour fresh money into top-rated funds even if their performance declines – just because the rating is still high.

So whether they agree or not, the fact is that the rating companies are a big beneficiary of their own ratings. Think about it. I know a few things. Others might know as well. But I am not saying anything more here… 😉 If you know what I am pointing to, you will understand. Else, ignorance is bliss.

And with a sustained rally in Indian equities for last many years, equity is no doubt turning out to be an attractive asset class. At such times, its all the more necessary that the role of mutual fund rating agencies is critically and subjectively assessed.

Maybe, the Fault is not in ‘Stars’ but in Us

Here I quote from an article by Barry Ritholtz that has some apt words:

Retail and professional investor alike seem to ignore the fact that every single document ever generated by any investment-related firm has a warning on it to the effect that “Past performance is not an indicator of future returns.” Every chart ever drawn, each investing idea back-tested and every single historical comparison is testament to how little mind humans pay to that disclaimer.

To borrow from and paraphrase the Bard, the fault lies not in the stars, but in ourselves.

Thus, it should come as no surprise that misunderstanding what fund ratings mean is a very typical error made by, well, just about everyone. It isn’t a forecast of future returns, nor could it be.

If it could successfully do that, [Mutual Fund Rating companies] would have long ago set up a hedge fund to profit from its newly discovered abilities to identify winning investments.

Sounds logical. Isn’t it?

Bottom Line

I reiterate that mutual fund ratings are fine as a concept and provide useful insight into a fund, how it has performed in the past and how it invests. But they are not meant to be used in isolation or as a predictive measure.

When it comes to things like ratings, you cannot build a perfect system. Never. But it’s your hard earned money. You should atleast know the limitations of factors on which you are basing your investment decisions.

The best way to invest in mutual funds in India is not by just looking at the mutual fund star ratings. Ideally, investors need to use data, do some homework and estimate how a fund might perform in future. And that is very important. The rating system alone does not have complete information for making such a subjective judgment.

So should you ignore mutual fund star ratings altogether? Or are mutual fund ratings useful? Or are mutual fund ratings of no use? And will 5 star rated funds perform better than all others? Are star ratings the best way to choose a mutual fund?

I have already shared my thoughts. It’s best if you decide about the final answers to these questions yourself.

Your Tolerance for Market Falls Is Probably Not What You Think

Risk Loss Tolerance markets

When markets fall or the economy goes into a recession, you will remain invested. Or better still, you will invest more (buy low philosophy) to ensure great future returns when markets recover.

Right?

That’s the plan?

Great! It is exactly how it should be. And staying invested (and investing more) in the market falls is how you can create a lot of wealth from stock markets.

But it’s easier said than done.

You ‘think’ that you will remain invested or invest more in market falls. But will you actually do it?

That is something that only time will tell.

But I feel that people’s tolerance for market falls is probably not what they think it is. I cannot prove it. But let me show you an example and maybe you will realize it too.

I am simulating a Rs 10,000 SIP in HDFC Equity Fund starting from January 2007.

I have picked this starting point for one reason. The returns just before Jan 2007, i.e. upto Dec 2006 were great and hence would have attracted many new investors into the market.

So these investors would have begun their investment journey having their own ‘easy money’ notions about investing due to (recent) past experience.

Now have a look at what happens to the value of the investments from January 2007 to March 2009:

Value SIP Market Fall

Observations

  • In the 1st year of SIP, the investor would be patting his back that it was the right decision to begin investing. By December 2007, the investment would be up by almost 30%.
  • But then came what we all remember – the great leveller – the crash of 2008-2009.
  • The investor would have continued his SIP of Rs 10,000.
  • By March 2009, his investments would have come down drastically. Value of total investment of Rs 2.7 lac would have been about Rs 1.7 lac. So from highs of around +34% to a gut-wrenching low of -35%.

And this is where I want to stop this simulation.

What happened after this is well known to all. Markets kept moving higher and higher… and higher.

But think about it.

How many people would have got the guts to remain invested after seeing a drop from +35% to -35%. I know many who lost money and exited.

The notion that equity will give high returns no matter what… is not correct. It’s a volatile asset class and will remain so forever. Investors need to realize that these things will happen whether they accept it or not. And when this happens, their tolerance for losses will be tested.

People have different tolerance(s) for big market falls:

  • When they think about market falls
  • And when market falls actually happen 🙂

How people feel about big falls depends almost entirely on what has been happening in the market recently.

Investors who are asked about their tolerance following high past returns are likely to overestimate it, swayed by exuberance. Investors who are asked following low past returns are likely to underestimate it, swayed by fear.

In rising markets, it’s very easy to claim that you will remain invested in big falls. But most people’s tolerance for portfolio falls is not what they think it is.

And just to clarify, it’s not about starting or stopping SIPs to time the market.

SIP is a small amount when compared with a multi-year old portfolio.

Assuming the investor in discussion is not a new one and already holds a Rs 20 lac portfolio at the start (with Rs 10,000 SIP running), here is what he will have to face in 2007-2009:

Mutual Fund Portfolio Fall

After having Rs 20 lac at the start with Rs 2.7 lac in fresh investments, it is not easy to see your portfolio go down to Rs 14.8 lac. And notice the fall from Rs 32 lac (in Jan-2008) to Rs 14.8 lac in March 2009.

This investor would be less worried about starting or stopping SIPs and more about containing the fall of his multi-lac portfolio that he had already built.

I don’t want to scare you.

For most common people, SIP in equity mutual funds is the best approach to benefit from stock markets.

My only aim with this post was to highlight that you need to accept losses ‘too’ when doing your SIPs. It cannot be one way up. Equity is not a bank FD.

So think about it.

Is your tolerance for market falls and losses really what you think it is? If not, teach yourself to overcome the fear when things really do get bad.

SIP Mutual Fund Maturity

Mutual Fund SIP Return Calculations – How much Wealth is Created?

SIP Mutual Fund Maturity

Do you wish to know how much your monthly SIP investments in mutual funds will grow over a period of 5 years, 10 years, 15 years, 20 years, 25 years or even 30 years?

Then you will find answers to all your SIP returns and monthly investment growth amount-related concerns here. And you don’t even need a SIP calculator as I have already done the hard work for you.

SIP investing can create tremendous wealth for you and to know is how much your money can grow when investing via monthly SIP in good mutual funds, simply click on any of the links or image below. All links take you to individual detailed posts that tell about the final value of the chosen SIP amount and model MF portfolios:

Or click on the images below:

Invest 10000 month SIP

Invest 15000 month SIP

Invest 20000 month SIP

Invest 25000 month SIP

Invest 50000 month SIP

Invest 1 lakh month SIP

Using the above links, you will have clear idea how your SIP investments will grow when you remain invested for 5 years, 10 years, 15 years, 20 years, 25 years or even 30 years!

Investing via SIP in best mutual funds for long-term is one of the best ways to begin your wealth creation journey. And since most common people are unable to big lump sum investments, SIP makes it very easy for such people to make small regular investments every month using their monthly salaries without feeling burdened. To convince you further, here is a Real Life Story of how one person accumulated Rs 3.7 crores via SIP investments over long-term.

But wealth creation is not the only benefit of SIP…

You can even use mutual fund SIPs to do your financial goal planning + invest regularly to achieve them. Saving for goals like children’s education, children’s marriage, retirement planning, saving for your house purchase, foreign trips, etc. can be done easily and profitably through systematic investment plans of mutual funds.

Here is a FREE (Downloadable) Financial Goal Excel Worksheet that you can use to plan out your financial goals.

As a professional investment advisor, I do help investors create goal-based financial plans to achieve their real financial goals. If you wish to get yourself a solid financial plan that tells you how much to invest, where to invest and for how long to invest for your financial goals, you can contact me for professional advice.

Here is how to contact me:

  • Go through the Services Page to see how I create your financial plan and use the form (at the end of the page) to contact me
  • Contact me directly using this form

So if you still haven’t done it, it’s time to start a SIP in Equity Mutual Funds.

I can assure you that over the next 5-10 years, you will create a lot of wealth and it will easily be one of your best financial decisions till date.