The Hindu Business Line : Risky to invest borrowed funds

I am a senior executive in a private limited company. I have investments of Rs 35 lakh in equities and mutual funds. I am a long-term investor with a 3-4 year investment horizon. I have some surplus borrowed funds of Rs 9 lakh for investment in mutual funds.

The cost of the borrowing is 10 per cent. Which are the mutual funds that merit investment for a 3-4 year period?

Would a SIP help to improve the returns? What is the average return that I can expect from the investment in top ranked equity funds?

S. Subramanian

We would not advocate investing borrowed money in equity funds, especially if you need the money within the next three to four years. We have a few points to make about your query:

At this juncture, Indian companies seem to be poised for strong earnings growth, as the economy accelerates. Therefore, investments in a good diversified equity fund could deliver returns of 10-15 per cent a year if you stay invested for a long period.

Funds such as the HDFC Top 200 Fund, HDFC Equity, Magnum Contra and Franklin India Prima Fund may be good options to consider. But having said this, there is no guarantee of returns with any equity investment. When financial experts say that equity investments can earn a 10-15 per cent annual return over the long term, they are referring to really long holding periods of 10 years or more.

And none of these numbers are carved in stone; there have been certain 10-year periods in the Indian market where an investor would have made only single-digit returns from holding stocks.

The shorter your holding period, the higher is the risk of your investment earning less than the 10-15 per cent expected from equities. You should not expect to earn a 10-15 per cent return from your equity fund year after year.

The value of your investment in equity funds may go sharply up and down from year to year, from a high positive return in one year, to a value erosion in another. You cannot, therefore, rely on your equity fund investment to generate a regular stream of income that will enable you to service your interest obligations at 10 per cent.

Since the cost of your borrowings is quite high at 10 per cent, you may have end up having to meet your interest obligations out of your other savings, if markets fall or remain flat.

The risk of temporary value erosion to your investment is particularly high now, after two years of spiralling stock prices and index values.

A systematic investment plan is not a tool that helps improve your investment returns. All it does is to prevent you from exposing too much of your savings to the risk of poor timing. An SIP allows you to phase out your investment over time so that you don't end up investing a substantial portion of your savings at a particular stock market level. In a steadily rising market, a lumpsum investment made at the beginning of the period would earn you a higher return than the SIP. In a falling market, the SIP would earn better returns.

Before taking any decision to invest in equities or equity funds, do look at how much of your savings are already allocated to equity and debt investments. If you are in the 30-40 year age group, you should probably keep to an allocation of 30-40 per cent to equity investments.

(Queries may be e-mailed to mf@thehindu.co.in, or sent by post to Business Line, 859-860, Anna Salai, Chennai 600002.)

Aarati Krishnan

Article E-Mail :: Comment :: Syndication :: Printer Friendly Page