The Hindu Business Line : Check cost of funds too

Every investor worth his salt should be more than just casually aware of the costs involved in dealing with mutual funds. To put it bluntly, costs can kill, especially if the investor concerned starts punting in funds, darting in and out of them in a way no sensible person would approve.

With this serving as the backdrop, most investors would agree that relatively high-cost funds could prove to be a drag insofar as their portfolios are concerned. The situation could actually turn worse if these funds fail to perform in line with the expectation of the unit holders.

Here are details of a review on mutual fund costs - it was conducted recently in the US but even an Indian investor would be able to glean nuggets of interesting information from it.

The study, taken up by ICI, the US body of investment management companies, points out that mutual fund costs continued to decline in the past year. In fact, average fees paid by investors were at lowest levels in more than 25 years.

Allow us to single out a few other findings. One, the total cost of investing in equity funds (in the US) decreased for the third consecutive year.

Two, a majority of investors' assets are in low-cost funds. Three, of the total assets held in equity funds, 90 per cent are in funds with below-average expense ratios.

Expense ratios

What led to the overall decline in MF fees? The trend was prompted chiefly by two factors. One, there was a sustained "investor migration" to lower-cost funds. Two, there were reductions in expense ratios, a matter that assumes an added significance in competitive market conditions.

So, are there any conclusions that even we in India should pay attention to? Yes, because not too many of us actively shop for low-cost funds. Yes, because we often get into NFOs without becoming fully aware of the expenses involved. And, yes, because a few of us think that fee structures can serve as important guides while we scramble for the best buys.

Cut to newcomer Quantum MF, which has made a special effort to do away with conventional distributors. An investor's returns from a fund, it has argued, are a function of two factors - gains on investment (read: efficiency of the fund manager) and costs/expenses. The latter may stem from the money that has been spent on collections, advertising, transaction in securities, investment management fees and the like.

"What investors can watch carefully, though, is the overall cost of collecting money for any fund and its ongoing expenses. Many fund houses, in a bid to gather large assets under management (wrongly seen by many investors as a sign of success) have relatively high distribution and marketing costs", Quantum has stated.

The cost of raising money through aggressively-publicised NFOs, while declared, gets eclipsed in bull markets. Short-term investors often feel that when stocks are up, say 50 per cent in a year, they need not worry about an extra cost or two. But long-term investors are only too aware that the market does not sprint 50 per cent every year.

Given these two very different perspectives, the disconnect between short- and long-term strategies is clear.

Do you wish to be a believer in low-cost funds that do not measure their success on the basis of money collected during NFO periods? Search for the answer in your heart.

Feedback may be sent to nilanjan@thehindu.co.in

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