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Investing in MFs? Get up-to-date

Arnav Pandya in Mumbai | February 02, 2009 16:16 IST

In the past one year, the mutual fund industry has been going through some serious trouble because of declining stock markets and stricter guidelines in debt schemes. This has forced many of them to introduce changes that will help garner more funds. Also, there are moves to discourage investors from moving funds too quickly.

Last January, the Securities and Exchange Board of India removed the entry load (2.25 per cent for equity schemes) for direct investors. This January, guidelines have been issued to regulate the investing strategy of liquid funds. Fixed maturity plans, which were doing rather well last year, now have to list at the stock exchanges. They also cannot declare indicative yields and returns anymore.

While fund houses communicate the changes in their policy through mailers or newspaper advertisements, many investors choose to ignore it. Here, we look at some of the changes that have occurred and how they could impact investment decisions.

Reduction of minimum investment: For a long period, investing in a mutual fund seemed like a big deal because the threshold limit was rather high. It was normal to find schemes targeting small investors in which the minimum investment requirement could be Rs 5,000- Rs 10,000. Some specialised schemes like sector funds or theme funds had a minimum investment of Rs 25,000.

Of course, there are specialised schemes that are only meant for the high net worth investors or even institutional investors where the minimum investment starts in six digits and can be something like Rs 1 lakh (Rs 100,000), Rs 10 lakh (Rs 1 million) or even Rs 1 crore (Rs 10 million).

Recently, quite a few schemes, especially debt mutual funds, have brought down the minimum investment amount to a few thousand rupees, thereby reducing the minimum requirement by a good 70-90 per cent.

This makes them more small investor-friendly. Though this is good news, investors need to more careful when they opt for schemes where the entry amount is really low. Being a very small stakeholder among many bigger players may sometimes hurt them. On occasions, there are sudden entries and exits by the bigger players that can lead to a frenzied sale of securities by the fund house. As a result, the net asset value of the scheme is hurt.

Small investors, who are a part of such schemes, can suddenly find that the value of their investment has slipped sharply. To avoid this, select schemes that have exposure to high-yielding corporate debt or are useful to complete a specific asset class exposure, according to the portfolio. 

Raising the exit load: Many fund houses have taken the route of hiking the exit load in their equity schemes. Earlier, most funds had an exit load of 0.5 per cent. Now it has gone up to 1 per cent or even 1.5 per cent. Though, this may not sound big, in tough situations, it becomes a significant number.

Already, investors in equity schemes have witnessed a sharp dip in their portfolio values in the last one year. Diversified equity schemes on an average have lost 51 per cent in the last one year and many of the worse performing schemes have lost between 60-80 per cent. With such an erosion in value, and the equity markets settling at lower levels, reclaiming the previous highs will require a large rally in stocks.

Many investors, in such circumstances, move their money in and out depending on the situation. This means if they find markets are trading in a narrow range, then they sell in a rally and then buy back the units at a lower rate. For example, an investor bought units in a scheme. After some time, the net asset value of the scheme starts slipping. Instead of waiting till the cost is reached, they will sell when the NAV goes up slightly and buy the units again when the NAV falls. This helps them to make small gains, usually between the range of 8-12 per cent to recover some of the losses.

Mutual funds, however, want to restrict this behaviour by raising the cost of trading. Now, investors looking to follow such a strategy will have to factor in the higher loads as significant parts of the gains could be taken away, in case short-term trading is done.

For such investors, the option will now be either to stay away from such moves or wait for higher gains.

Increasing the load period: Apart from the actual load itself, what has also happened is that the time period for which load will be applicable has been increased. That is, if there was an exit load for investments redeemed within a period of six months from the date of investment, this time period has now been hiked to 12 months or even 15 months.

The rise of the period to 12 months means that there will be a double whammy for equity investors. In case of tax, there is short-term capital gains tax of 15 per cent plus the exit load. Even in case of a loss, the load will be applicable, leading to a worsening in the situation.

Further, if the exit load is hiked to 15 months, the problem is one of mismatch with the taxation. Today, if one exits an equity scheme after a year, there is no long-term capital gains tax. However, with a 15-month exit load structure, an investor will still have to pay it even though there is no tax.

The writer is director, My Financial Advisor.

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