Mutual Fund investing myths

Mutual funds are an effective engine to route your investments in the equity markets. They offer several advantages over direct stock picking viz., diversification, professional management, light on wallet, economies of scale, liquidity, etc. But even after knowing the importance of investing in mutual funds, very often, we see that mutual fund investors are surrounded by myths based on widely held, yet incorrect beliefs and also based on flawed information. Both these kinds of myths can consequently lead investors to make incorrect investment decisions. We'd like to take this opportunity to debunk some common mutual fund investing myths:

Myths based on Incorrect Beliefs

When asked why the avid investor of stocks/shares does not take to mutual funds with the same passion and enthusiasm, the likely response is that mutual funds investments are dull and boring. They lack the thrill that one gets by investing in stocks. Bringing us to Myth # 1:

· Mutual funds lack excitement

"Who wants to invest in a staid investment like a mutual fund that probably grows half as fast as some 'exciting' stocks like Infosys, ONGC or BHEL during a bull run?" The poser is relevant. Underperformance almost always gets the thumbs down, no matter what the reason. After all, every investor wants his money to work for him and if a stock does that better, why invest in a mutual fund?

Yes, stocks can be exciting. And mutual funds may lack the excitement of a stock, but it's the kind of excitement that investors can do without for their long-term wealth as well as health. Mutual funds may not give an impetus to the investor's portfolio in a bull run like some 'exciting' stocks. But, you can be sure that they won't burn a huge crater in the investor's portfolio either. Something that could be inevitable, should individual stocks be crashing by say 40%.

· Mutual funds are too diversified

"Mutual funds own too many stocks to be of any serious benefit. A focused portfolio of 8-10 stocks will generate a more attractive return than a mutual fund portfolio comprising 30-40 stocks."

We are not sure if there is any theory to prove or disprove that concentrated portfolios (8-10 stocks) do better than diversified portfolios (30-40 stocks) in the Indian context. Of course, Mr. Warren Buffet has successfully managed a small portfolio over a long period of time. But, not too many investors can claim to have his investment discipline, insight and experience. In the absence of these important traits, it would be incorrect to expect a concentrated portfolio to outperform a diversified portfolio, at least over the long-term (3-5 years).

Remember, fund managers are experienced money managers and their mandate is to outperform the benchmark index of the fund. And if these experienced managers have chosen the diversification route that tells us a little about how to go about making money in the stock markets.

· Mutual funds are too expensive

"Mutual funds aren't cheap. On an average, the recurring expenses for a diversified equity fund ranges from 2.25% to 2.50% of net assets."

The 2.50% (maximum) recurring expenses charged by the mutual fund go towards meeting the brokerage costs, custodial costs and fund management cost. These are expenses that stock investors incur as well (barring the fund manager's salary). Consider this, when you have a competent fund manager who combines his time, effort and expertise to research stocks and sectors to pick his best 30-40 stocks and also buys and sells them for you, you have someone who is doing a lot of work for you and is charging only a maximum of 2.50% of your investments. Of course we agree that this must be followed by sheer out performance of the benchmark index and even peers. You don't want to pay for underperformance.

The good news is that quite a few diversified equity funds have managed to put in what can be termed as 'a very good performance' over 3-5 years vis-à-vis the benchmark index and peers. Which are these funds, you ask?

Scheme	6-mth (%)	1-Yr (%)	3-Yr (%)	5-Yr (%)	Since Incept.
IDFC Small & Midcap Equity (G)	-6.96	10.66	23.08	-	21.93
ICICI Pru Discovery (G)	-4.53	11.37	20.04	13.19	26.93
HDFC Equity (G)	-5.00	17.54	18.19	16.53	22.74
Quantum LT Equity (G)	-4.12	16.37	16.51	16.70	17.29
Mirae Asset India Oppor-Reg (G)	-4.50	11.91	16.41	-	17.86
HDFC Top 200 (G)	-5.22	15.70	15.81	16.65	23.27
Reliance Equity Oppor-Ret (G)	-7.62	12.26	15.74	13.45	23.40
IDFC Premier Equity-A (G)	-8.06	12.81	15.67	20.49	23.75
DSPBR Small & Mid Cap-Reg (G)	-9.06	12.88	15.53	-	13.99
UTI Master Value (D)	-6.32	14.86	14.42	11.81	23.22
BSE SENSEX	-5.34	8.48	5.02	10.05	NA
S&P CNX Nifty	-5.71	8.81	4.93	10.24	NA

· Performance as on April 18, 2011

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