Mutual fund tricks and treats

Manubhai Patel turned 74 this year, and has been investing regularly in mutual funds since 1992. Building his investments in mutual funds since then, Patel says, “I have invested in around 98 per cent of equity and balanced schemes currently available in the market.”

By investing in so many schemes, Patel feels he has ensured that his investment doesn’t suffer losses if a few schemes do not do well. But, experts say that he is investing in too many schemes. Sandeep Shanbhag, director, AN Shanbhag NR Group, an investment and tax advisory says: “The raison d’etre of a mutual fund is diversification of risk. A mutual fund invests across industries and companies. Hence the risk associated with any one industry or stock of one company is reduced to that extent.”

He says he often finds that investors have a portfolio of mutual funds just as one would have a portfolio of stocks. “When you invest with the first mutual fund, you have already diversified the risk. Over time, one may add three to five schemes more to benefit from different fund management styles. Beyond that, one just climbs down the quality ladder and actively sub-optimises the return potential,” Shanbhag suggests.

Patel also makes it a point to take the dividend option. Investors usually have two options while investing in a mutual fund scheme, dividend and growth. In a dividend option, investors may get dividends at regular intervals, whereas in case of a growth option, the investment just keeps growing (or falling as the case might be), till they decide to sell out.   

Patel is happy to receive a dividend a day from the many mutual fund schemes that he has invested in. He is no exception to what seems to have become a rule. Investors prefer mutual funds that give dividends. What they fail to realise is the dividend is their own money being returned to them.

Suppose a mutual fund declares a dividend of Rs5 per unit. After the dividend is given, the net asset value (NAV) of a single unit of a mutual fund falls by Rs5. This happens because mutual funds have to sell some of the shares they have invested in to give out the dividends.

Amar Pandit, a certified financial planner who runs My Financial Advisor, says, “People generally compare the dividends on mutual funds with dividends given on stocks and believe that dividend is the additional return over and above the capital appreciation that happens. Mutual funds should partly take the blame for this as they aggressively market dividend announcements,” he adds.

Investing in a mutual fund just because it is about to declare a dividend is not a healthy habit. Investors should thus look at the performance of the scheme, over a period of 3-5 years before deciding to invest in it.

Patel knows that post-dividend the NAV of the scheme drops. “I don’t care about the NAV dropping. I am getting my dividend,” he says.

Other than this, Patel invests in new schemes because he gets more units by investing in them. In case of a new mutual fund scheme, a single unit is issued at Rs10. Hence an investor who decides to invest Rs10,000 in this new scheme will get 1000 units (Rs10,000/10). Now if the same investor decides to invest in an exisiting scheme with an NAV of Rs100, he will get 100 units (Rs10,000/100) only.

And he doesn’t like holding lesser number of units. One year later the NAV of both the schemes appreciates by 25 per cent. Accordingly, the NAV of the new scheme would increase to Rs12.5 (Rs10 + 25 per cent of Rs10) and the NAV of the old scheme would be Rs125 (Rs100 + 25 per cent of Rs100). The value of the investment in the first case would be Rs12,500 (Rs12.5 x 1,000). And Voila! The value of the investment in the existing scheme would also be Rs12,500 (Rs125 x 100). So, what matters is the kind of stocks the mutual fund decides to invest in.

Pandit says, “People only look at absolute numbers while making financial decisions and hence tend to believe that a Rs10 NAV is cheaper than a Rs100 NAV investment. Most investors do not realise that a scheme’s value is derived from the underlying stocks that it invests in. So if TCS falls by 5 per cent it will have the same impact on the scheme which has a NAV of Rs10 as well as the scheme which has Rs100 NAV, assuming both the schemes have the same number of TCS shares.”

But this has become a huge mis-selling trick. Suresh Sadgopan, a certified financial planner who runs Ladder 7 Financial Advisories, says, “When a new scheme is launched it is prominently advertised that an investor can get units at Rs10. Mutual fund agents flog this to the hilt.”

Also, the commission that agents earn on new schemes is greater than what they earn when their clients stay invested in a scheme. An investor may not have the money to invest whenever a new scheme is launched. Hence the easy way out for agents is to get him to exit an existing scheme and cajole him to invest in a new scheme. “Mutual fund agents nudge investors to exit their existing schemes, as they have ‘already made a profit’ and get them into the ‘never before opportunity’ of a new scheme”, says Sadgopan. 

In mutual fund jargon this is referred to as churning. But big distributors like banks are taking steps to control this. Sonu Bhasin, Sr Vice President — Wealth Management Group at Axis Bank said, “Training and month end checks are conducted. We have a research team in place that recommends certain mutual fund schemes based on 14-15 parameters. We ensure that 90 per cent of the sales are from this list of recommendation. The net sales in a month are continuously monitored. If the sales in a month are equivalent to redemptions then we ask the branch for the churning details.”  (Manubhai Patel is not the real name of the individual concerned. His name has been Patel is happy to receive a dividend a day from the many mutual fund schemes that he has invested in. He is no exception to what seems to have become a rule. Investors prefer mutual funds that give dividends. What they fail to realise is the dividend is their own money being returned to them.

Suppose a mutual fund declares a dividend of Rs5 per unit. After the dividend is given, the net asset value (NAV) of a single unit of a mutual fund falls by Rs5. This happens because mutual funds have to sell some of the shares they have invested in to give out the dividends.

Amar Pandit, a certified financial planner who runs My Financial Advisor, says, “People generally compare the dividends on mutual funds with dividends given on stocks and believe that dividend is the additional return over and above the capital appreciation that happens.

Mutual funds should partly take the blame for this, as they aggressively market dividend announcements,” he adds.

Investing in a mutual fund just because it is about to declare a dividend is not a healthy habit. Investors should look at the performance of the scheme, over a period of 3-5 years, before deciding to invest in it.

Patel knows that post-dividend the NAV of the scheme drops. Other than this, Patel invests in new schemes because he gets more units by investing in them. In case of a new mutual fund scheme, a single unit is issued at Rs10. Hence, an investor who decides to invest Rs10,000 in this new scheme will get 1000 units (Rs10,000/10).

Now, if the same investor decides to invest in an existing scheme with an NAV of Rs100, he will get 100 units (Rs10,000/100) only. And he doesn’t like holding fewer number of units. One year later, the NAV of both the schemes appreciates by 25 per cent. Accordingly, the NAV of the new scheme would increase to Rs12.5 (Rs10 + 25 per cent of Rs10) and the NAV of the old scheme would be Rs125 (Rs100 + 25 per cent of Rs100).

The value of the investment in the first case would be Rs12,500 (Rs12.5 x 1,000).  The value of the investment in the existing scheme would also be Rs12,500 (Rs125 x 100). Says Pandit:“People only look at absolute numbers while making financial decisions and hence tend to believe that a Rs10 NAV is cheaper than a Rs100 NAV investment. Most investors do not realise that a scheme’s value is derived from the underlying stocks that it invests in. So, if TCS falls by 5 per cent, it will have the same impact on the scheme which has a NAV of Rs10 as the scheme which has Rs100 NAV, assuming both have the same number of TCS shares.”

But this has become a selling trick. Suresh Sadgopan, a certified financial planner who runs Ladder 7 Financial Advisories, says, “When a new scheme is launched, it is advertised that an investor can get units at Rs10. Mutual fund agents flog this to death.”

Also, the commission that agents earn on new schemes is greater than what they earn when their clients stay invested in a scheme. An investor may not have the money to invest whenever a new scheme is launched. Hence, the easy way out for agents is to get him to exit an existing scheme and cajole him to invest in a new scheme.

“Mutual fund agents nudge investors to exit their existing schemes, as they have ‘already made a profit’ and get them into the ‘never before opportunity’ of a new scheme”, says Sadgopan. 

In mutual fund jargon, this is referred to as churning. But big distributors like banks are taking steps to control this. Says Sonu Bhasin, sr vice-president, wealth management group, Axis Bank said, “Training and month end checks are conducted. We have a research team in place that recommends certain mutual fund schemes based on 14-15 parameters. We ensure that 90 per cent of the sales are from this list.

The net sales in a month are continuously monitored. If the sales in a month are equivalent to redemptions then we ask the branch for the
churning details.” 

(Manubhai Patel is not a real name)