The Hindu Business Line : Fund Talk

When evaluating a fund’s portfolio, first compare the fund to its benchmark and assess how it has performed against it over, say, 18 months to two years.

In last week’s column, you said that the growth option outperforms dividend option over the long term. At the same time, you advised investing in dividend option as erosion during downslide of the market is contained. I am confused. Please explain how investments in the dividend option are protected during a correction? Suppose I have to invest Rs10 lakh in mutual funds for a five to 10-year time-frame, what percentage should I invest in Growth and Dividend options? I find some funds underperforming their peer group for one or two years, but improving their performance later — Birla Sun Life Frontline Equity is an example. If the investment horizon is five to 10 years, should an investor change the fund, if a particular fund’s performance is not good for one or two years?

R.T.Namasivayam

Declaration of dividend is done at the fund’s discretion. This means funds can well choose to skip declaring a dividend one year, or vary the quantum of dividend from year to year. Choosing the dividend option is not for investors who seek regular income from equity funds; rather, it is for investors who are not sure how to time their investments in funds.

History suggests that funds often pay hefty dividends when they sense they are nearing a market peak. For instance, many top-performing funds declared huge dividends before the tech meltdown in 2000.

With the dividend option, you are able to cash in on your investments in a timely manner. In the growth option, the decision to exit is solely at your discretion. You run the risk of exiting too early and missing out on potential returns, or exiting too late and witnessing sharp erosion of your portfolio returns.

But this dilemma of timing is faced only by short-term investors — those with a time horizon of less than five years. If you are willing to stay with the market over a 10-year time-frame through its ups and downs, the growth option is better. If you hold on, returns from the investment will eventually be healthy, after the temporary fluctuations. There is also a re-investment risk associated with opting for the dividend option. You typically re-invest dividend income in bank deposits or liquid funds, which may underperform equities over the long term. In light of this, you should:

Opt for the dividend option if you are a conservative investor, have a short time-frame and if you are uncertain when you will need cash. You can also opt for the dividend option for riskier funds such as mid-cap funds or theme/sector funds.

Opt for the growth option if you are a long-term investor and do not need the funds you have committed to equity any time soon. But remember to periodically re-balance your equity portfolio in tune with your changing requirements and risk profile.

On your second query, when evaluating a fund’s portfolio, first compare the fund to its benchmark. If it has underperformed its benchmark consistently over a prolonged period, say over 18 months to two years, then either it is not sticking to its investment mandate, or its investment strategy has backfired and the fund has not been adept at correcting its course.

Either way, you might have to evaluate whether it’s worth owing the fund. You might be better off switching to a fund with a better track record.

A fund’s performance relative to its peers is equally important. When the majority of funds outperforms or even underperforms the key benchmark indices over a particular period, peer-group performance is important.

However, an apple-to-apple comparison needs to be made. You need to compare funds that have the same benchmark and that have a similar investment focus or strategy.

A fund might underperform its peer group for a variety of reasons. It might be more conservative in its investment style. It might be taking exposures to stocks or sectors that might underperform in the near term, but pay off over the long term.

For funds with a strong long-term track record, an underperformance vis-À-vis the peer group in a year or two might just be a temporary blip. A long-term investor should certainly hold on to such funds, so long as it manages to beat its benchmark.

SHANTHI VENKATARAMAN

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