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Sunday, Mar 20, 2005

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Have mutual funds got it right, finally?

Suresh Krishnamurthy

THERE has been a spate of initial public offers by mutual funds in recent months. These IPOs have been attracting record subscriptions and ominous parallels are being drawn with what happened in 2000.

The tendency of asset management companies to set aside investor interest without any compunction and focus only on business growth also needs to be considered.

Also add to the concoction the penchant of retail investors to invest when stock prices are at a high and divest when prices decline. Then, concerns that investors are set to lose money once again would seem justified.

Fortunately, however, the kind of products launched by most mutual funds can cause considerably less harm than the products launched in 2000. Equities as a class are also much better placed to deliver superior returns than they were in 2000.

Mutual fund investors, however, still need to exercise caution. First, they need to enter the market with a fairly long-term perspective. They also need to balance return expectations with their risk profile.

With mutual funds delivering three straight years of positive returns, investors may fall prey to assertions that equities can go just one way — northwards.

Assets under management of cautious and aggressive schemes also suggest that investors are favouring aggression now.

Unfortunately, the market has its own way of disciplining investors. If their attention to the risk profile slips, even briefly, the equity market can damage their interests.

Rights offers: In 2000, most mutual funds came out with sector funds. In 2001 and 2002, they launched index funds. Reason: those were the products that would attract maximum subscription under the circumstances.

Needless to say, both products would have harmed the investor.

Products launched now are far more suitable to the investor and designed to take advantage of the likely market trends over the longer term.

Theme-based products such as Opportunities, Flexi-Cap or Multi-Cap and Mid-Cap funds fulfil a felt and justified need of the investor. Notwithstanding their business focus, mutual funds appear to have got it right this time around.

These theme-based schemes are diversified equity funds. They are designed to take advantage of the expected growth in industry.

If investors hold on to their mutual fund investments long enough, eking out returns of 9-15 per cent per annum appears probable. Far more important is the prevailing low level of interest rates. The expected post-tax returns of 6 per cent from debt investments make equities justified and necessary right now.

Aggression personified: A booming stock market never fails to bring to the surface the aggressive streak in investors. This time too it has been no different.

With the successful public offers of Franklin India Flexi-Cap and Reliance Opportunities Fund, the assets under management of aggressive funds are now more than those of cautious funds.

Cautious funds include diversified equity funds benchmarked against Nifty or Sensex and the index funds. Diversified equity funds benchmarked against BSE-200, S&P CNX-500, sector funds and mid-cap funds are considered aggressive funds. These funds now dominate the mutual fund universe.

The proportion of more than 50 per cent of assets under management in aggressive funds is not alarming. Sensex or Nifty stocks themselves are less than 50 per cent of the overall market capitalisation of all stocks.

Flow of more money into mid-cap or small-cap stocks now, however, through Flexi-Cap or Opportunities Fund does not appear justified.

In addition, investors have to discern their own risk profile. It would appear quite out of place if investors who have till date invested only in bank term deposits place their faith in a Flexi-Cap or Opportunities Fund.

Such investors, with their limited understanding of the market, will find that volatility tests their faith time and again. It would be far better if these investors park their funds in diversified large-cap funds with established credentials.

The tide also appears to be slowly turning in favour of select large-cap stocks. Considering the expected growth in industry too, investing in large-cap stocks is logical.

Larger companies are much better placed to take advantage of a growing economy. Investing in a large-cap fund is appropriate even from the perspective of expected returns.

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