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What falling AUMs mean for your mutual fund

July 24, 2008 08:43 IST

In a trend that shows no signs of abating, investment advisors continue to find ingenious reasons to make their investors churn their mutual fund portfolios. Now some investment advisors are raising the red flag on falling AUMs (assets under management of the mutual fund, also referred to as net assets). They are telling investors to redeem funds that are seeing a drop in their net assets because this is a sign that those funds are in trouble.

Surprised? Redeeming funds would mean a fall in the advisor's AUM; that in turn would mean a loss in income for the advisor one might say. Well, the key here is that the investor is being persuaded to churn his portfolio i.e. redeem his holdings from a fund and invest in another.

Of course, there's more than a fair chance that the second fund is also losing AUM on account of the falling markets. But then there's a stronger possibility that the second fund belongs to a fund house that has recently announced a contest/attractive compensation structure to incentivise advisors to combat the challenge posed by falling markets. Of course, none of this is likely to find mention in the advisor's sales pitch.

Coming back to the falling AUM problem. Indeed, stock markets are falling sharply. Equity funds, particularly thematic/sectoral funds are among the biggest losers. Their net assets have fallen hard to reflect the drop in the value of the underlying stocks.

To compound matters, nervous investors are redeeming their investments, which only accelerates the fall in the net assets of these funds. To already anxious investors who haven't yet redeemed their investments, this is worrying. Investment advisors are not helping matters any by making a case out of this for redeeming at the earliest.

Investors who are led to believe that falling net assets is a sure sign that the fund is in trouble and must therefore exit the fund at the earliest, must consider some points first.

1. Unlike stocks, which have a market value (which could be distinct from the book value) mutual funds are valued based on their net asset value (NAV). The NAV of a mutual fund corresponds to the book value of a stock. The NAV is arrived at by calculating the market value of the investments net of expenses. In other words, even if the net assets of a mutual fund are falling, investors do not have to worry about whether they will get their money at the time of redemption.

2. Another point to note is that net assets of mutual funds are falling sharply because markets are falling sharply; it does not necessarily mean that only your fund is in trouble. If markets have slid by over 30%, as they have over the last few months, it would take a miracle for an equity fund to swim against the tide and post a positive growth in its net assets. So falling net assets must be seen from this perspective. Compare your fund with the broad market and its peers and if it's down a lot more than them, then maybe there is a cause for concern.

3. Now is a good time to evaluate why you invested in the fund under question. Aggressive/thematic funds will usually fall harder than the broad market. On the flipside, such funds are structured to give commensurately higher returns during a market rally.

So if you have invested in an aggressively managed diversified equity fund or a thematic/sector fund, then do not be surprised if its net assets fall sharply in these markets; that is only to be expected. If you invested in the fund knowing it was an aggressive fund, then there is no reason to redeem it now, unless there are some fundamental reasons for the same.

While there can be several reasons to redeem your mutual fund, falling net assets is certainly not one of them. Falling net assets does not mean that the fund is in trouble and cannot honour redemptions. In these times, it only means that the fund's net assets are responding to the sharp fall in equity markets. If you nonetheless want to redeem your mutual fund, then do it for the right reasons.

Your family's future depends on this. Read now

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