INVESTING IN EQUITIES THROUGH

MUTUAL FUNDS

ARINDAM GHOSH
We have innumerous demands in our life to deal with, innumerous dreams to give shape
and innumerous commitments to fulfill in our lifespan. A dream home for comfortable
stay, a dream car to move around, a good education for children, a holiday at foreign
destination, an early retirement – the ends may be different, but the means probably the
same—money. Earned wisely, saved regularly and invested smartly.

We all have our own way of earning, may be from service, business or profession, but
the essence of our discussion is regular and smart investment of our earnings. The
question is not now investment only, it is smart and wise investment, i.e. choosing
among the best alternative from a number of options. And over time Equity stocks has
provided the best performance as far as return is concerned.

Cumulative annualised returns of different asset classes

(1985 – 2008*) Source: CLSA

Equity 17.9 17.9 %

G Sec 11.6 11.6 %

Bank FD 10.6 10.6 %

Gold 8. 8.1 %

(% Annualized returns)

0.0 5.0 10.0 15.0 20.0

The chart shows that in Indian market during last 23 years equity has really
outperformed. But the unfortunate part of it is that even then the Indian investors tend to
remain content with the traditional investment options like Bank Fixed Deposits, Govt
Bonds and Securities, Post Office Savings and Insurance. But all of them failed to beat
the present rate of inflation. Just pause for a second to think that the inflation rate is
around 12% and your Provident Fund or Post Office Savings are giving you a return of
8.5%. Then are those really fruitful investments or a slow erosion of your hard earned
money? But although the return on equity gives a very rosy picture one should not forget
the point that the above analysis is made on the basis of a long range data, i.e. one
should have a long term view of investment while investing in stocks. This is true that
Stocks are not expected to beat the Bonds and Securities every year, but the long-term
investors should put bulk of their assets in variety of Stocks.

But where is the problem? If we agree that no other investment can give us as much as
we can expect from equities, who is holding us from investing in Share Market? It is no
other than our awareness, knowledge and understanding of the market. In today’s world
of global communication, information is not a costly thing, but the analysis and
understanding of that analysis definitely require some expert knowledge which one may
acquire through in-depth studies. Again, does everyone have the required time to study
and learn all these intricacies after maintaining his own official or business schedule?
Probably very few can. So? Should the rest be rested on their traditional investments
only and earn a return insufficient to beat the inflation? The answer is NO. They also
should invest in equities only and invest through Mutual Funds. Understand what you
want from your investments, and leave the rest to the money managers: Mutual Funds.
These investment vehicles don’t demand your deep understanding of financial matters
and they don’t even demand investment of your precious time.

A Mutual Fund is a trust that pools the savings of a number of investors who share a
common financial goal. Anybody with an investible surplus of as little as a few hundred
rupees can invest in Mutual Funds. These investors buy units of a particular Mutual
Fund scheme that has a defined investment objective and strategy. The money thus
collected is then invested by the fund manager in different types of capital market
instruments such as shares, debentures and other securities. These could range from
shares to debentures to money market instruments, depending upon the scheme’s
stated objectives. The income earned through these investments and the capital
appreciation realised by the scheme are shared by its unit holders in proportion to the
number of units owned by them. Thus a Mutual Fund is the most suitable investment for
the common man as it offers an opportunity to invest in a diversified, professionally
managed basket of securities at a relatively low-cost.

The flow chart below describes broadly the working of a mutual fund:
The advantages of investing in a Mutual Fund are manifold:

Professional Management: The most important advantage one gets by investing

through Mutual Fund is the help of a professional management which manages the fund
in the best possible manner. We just entrust them to control our invested funds and the
fund manager, by virtue of understanding investments and being in the market, assess
various options with the help of a well qualified and dedicated research team which
analyses the performance and prospects of companies and invest accordingly for us to
achieve the objectives of the scheme. They earn performance based incentives and
higher the return they earn for us, higher is their incentives. At the end of third week of
July, 2008 whereas all other tax savings (ELSS) funds have given a minimum one-year
negative return of 11% , Sundaram Tax Saver reduced by 0.44% only. This is the effect
of a professionally managed Fund house that could set this example.

Diversification: Conventional investment wisdom says “Do not put all your eggs into
one basket”, which means we should always spread our risks while investing. We should
not only diversify among asset classes, i.e. Equity and Debt, but also among various
sectors and various stocks within each sector. Mutual Funds invest in a number of
companies across a broad cross-section of industries and sectors. This diversification
reduces the risk because seldom do all stocks decline at the same time and in the same
proportion. That way, if a part of our portfolio were to go through a downturn, gains from
others may offset the erosion. The investment strategy adopted by the Mutual Funds is
diversification and bounded by law they can not invest more than 10% of their total funds
in any particular company. Hence we may have the taste of a diversified and less risky
portfolio with Fund with far less money than you can do on your own through Mutual
Fund.

Return Potential: Over a medium to long-term, Mutual Funds have the potential to
provide a higher return as they invest in a diversified basket of selected securities. As on
31st of December, 2007 the study shows the following:

BENEFIT OF LONG-TERM INVESTMENTS IN MUTUAL

FUNDS
Mutual Fund Returns (annualised CAGR %)

3 years 5 years 7 years 10 years 12 years

Highest MF Returns 65.7 72.6 52.8 43.1 37.3
Lowest MF Returns 31.3 36.7 18.6 19.2 14.7
Peer Group Returns 49.0 54.4 36.1 34.1 27.6
Index Returns 43.4 41.2 25.3 19.0 17.2

Source: CRISIL

Small Investments: Mutual Funds target the small investors. Most schemes keep their
minimum investments at Rs.1000-5000. For an affordable amount one can start
investing in Equity market through Mutual Fund only. Particularly among Salaried
persons Systematic Investment Plan (SIP) is very popular where one can invest an
equal amount every month on a particular date of his choice by Post-dated cheques or
Auto debit facility. Thus not only a good amount can be accumulated bit by bit, but also
the benefit of Rupee Cost Averaging can be availed.

Liquidity: While investing by yourself, selling may sometimes be a painful proposition.

Tax free Bonds, PPF does not allow premature withdrawal, Bank FDs also penalize you
for it. Real Estate and Arts may offer you a return higher than equity but their liquidity is
very low. In open-ended schemes, you can get your money back promptly at Net Asset
Value from the Mutual Fund itself whenever you want. With close-ended schemes, you
can sell your units on a stock exchange at the prevailing market price. Most funds mail
your redemption proceeds within three to five working days.

Low Costs: Mutual Funds are a relatively less expensive way to invest compared to
directly investing in the Share markets because the benefits of scale in brokerage,
custodial and other fees translate into lower costs for investors.

Convenient Administration: Mutual Fund reduces paperwork and helps you avoid
many problems such as bad deliveries, delayed payments and unnecessary follow up
with brokers and companies. Mutual Funds save your time and make investing easy and
convenient

Transparency: You get regular information on the value of your investment in the
website of the Mutual Fund and AMFI in addition to disclosure on the specific
investments made by your scheme, the proportion invested in each class of assets and
the fund manager’s investment strategy and outlook.

Flexibility: According to your needs and convenience Mutual Funds offer a variety of
schemes to suit your varying needs. Apart from one time investments, there are
alternatives of Recurring Deposits, MIS, Fixed Deposits and many more to suit the need
of everyone.

Choice of schemes: In India there are 956 different schemes from 34 houses giving a
wide choice for everybody to invest in Mutual Fund.

Tax benefits: The Dividends distributed by the Mutual Funds are tax free and the
assessee also can take the benefit of Indexation (adjustment of Inflation) in case of
Capital Gain and Capital Loss also can be set off against other incomes. Moreover Long
Term Capital Gain also is exempt from Tax in case of Equity Funds.

Well regulated: All Mutual Funds are registered with SEBI and they function within the
provisions of strict regulations designed to protect the interests of investors. The
operations of Mutual Funds are regularly monitored by SEBI.

Now let us throw some light on the success story of the Mutual Fund industry. Starting in
the year 1964, the industry has gone a long way. From Rs.25.00 crores in 1965 the
Asset Under Management (AUM) has grown upto Rs.505152 Crores in 2008.
 GROWTH OF AUM SOURCE : AMFI

540
510
Thousands

480
450
420
390
360
330
300
270
240
210
180
150
120
90
60
30
0
1965 '74 '87 '93 '03 '04 '05 '06 '07 2008
It is said that the Mutual Fund industry is still in its infant stage. The ratio of AUM against
Bank Deposit is as low as 25% in India, whereas in developed market such as the USA,
the ratio is 148% and even in Brazil the same is 96% . And the research shows that the
industry is set to treble its assets within 2013 and six-times within next five years. This
indicates that there is much scope of growth in this industry till now. In fact, 75% of total
investments of the Fund houses are coming from top eight cities. The reason behind is
not only concentration of rich people in metros , but lack of awareness also plays a vital
role behind such a discriminating outcome. Now the Fund houses also started giving
thrust to tier II and tier III cities.

During my long stay in Sikkim and more particularly working in the field of finance I
noticed that here also the conception of Mutual Fund investment is not very clear among
the mass. As such the people of Sikkim are mostly happy with the traditional and
conventional investment opportunities like Insurance, Post Office savings and Bank
Deposits. But although those are absolutely risk-free but the returns are mostly
insufficient to beat the inflation. But mainly due to lack of awareness and absence of
proper advisory services people of Sikkim could not avail the opportunity of investing in
Mutual Funds.
One more reason has been the requiremet of PAN Card which was made mandatory
from 2007. But later on vide Circular No. MRD/DoP/MF/Cir-08/2008 it was made clear
that ” In the light of the representations received regarding similar exemption for
investments in mutual funds, it has been decided to exempt investors residing in the
state of Sikkim from mandatory requirement of PAN for their investments in mutual funds
also. Howerver, this would be subject to the mutual funds verifying the veracity of the
claim of the investors that they are residents of Sikkim, by collecting sufficient
documentary evidence. Mutual Funds are also advised to ensure strict compliance with
the applicable ‘Know Your Client’ norms” . But still it is better to avail the PAN Card
because any investment for Rs.50000.00 or more in Mutual Fund will require submission
of PAN Card. Having PAN Card does not mean that you have to pay Tax, for getting
refund of the Taxes Deducted at Sources (TDS) you have to have a PAN Card. And the
Government also thinking of making PAN mandatory in case of investments in Insurance
and Bank/PO deposits above a certain amount. And making a PAN Card also is not
difficult. By filling a Form (Form No.49A) and depositing with your address and identity
proof and the requisite fees, one may have his PAN Card within 15-20 days time.

In conclusion , one must agree that investing in equities has no alternative these days
both for high networth individuals (HNI) and the middle and upper middle class pleople.
But one shuold also understand the philosopy of investing. If we plant a seedling and
everyday pick it up from the pot to see how much it has grown, it can”t satisfy you.
Similarly all your investments also require a reasonable time to show you results. And
standing on today, where the Sensex is nearing the lower bottom level, three years may
be taken as a reasonable. Only thing you have to do is to pick up the right Fund that
suits your requirement and risk appetite and just stay invested. Lets conclude with a
quote of Bill Gates “If you are born poor, its not your mistake. But, if you die poor
its your mistake.”

[Author is an M.Com (Gold Medalist), Cost Accountant, and former Area Manager
of LIC Housing Finance Ltd, Gangtok. He is presently working as a Financial
Advisor and can be contacted in 9474688799 or arindamgtk@yahoo.com]

* * *