Reading between the lines of a mutual fund sales pitch…

Today the MM industry is a highly competitive industry where a few large players are vying for a growing share of the retail investor mindshare. This typically leads many mutual fund companies to be aggressive and therefore it behoves upon mutual fund investors to read between the lines. Let us understand a few such classic cases…

Our funds outperformed the index by a huge margin…

You will find that most mutual fund advertisements tend to be aggressive in making their sales pitch. When a mutual fund claims that their equity scheme outperformed the index by a huge margin, then there are lot of sub-texts to it. As a mutual fund investor, therefore, you need to ask the right questions. Let us consider some of them…

When the mutual fund claims to have outperformed the index, check the period they are referring to. A short period of 3-6 months may not be too indicative and could be more an exception than a rule. Ideally look at the outperformance over 1 year, 3 years and 5 years to get the best perspective. Also ensure that the benchmark is correctly selected. You need to compare apples and apples. There is no point if a mid-cap fund has outperformed the Nifty or the Sensex. You need to ensure that the fund has consistently outperformed the mid-cap index. When you are comparing funds, be very careful that you consider the risk element. Moderate return with low risk is always better than high returns with a heavy risk element.

Loads and no-loads can be a two way game…

To cut a long story short, there is nothing like a no-load fund. Different funds have different cost structures; which changes with the nature of the fund. For example, an index fund does not require active management and hence it has a lower cost as compared to an actively managed fund. Many funds claim that they are no-load funds. As an investor you need to read between the lines. A no-load fund is not necessarily a no-cost fund.

Every fund has a cost and that has to be passed on to the unit holder. There are costs in the form of administrative costs, employee costs, regulatory costs, execution costs etc… All these costs cannot be borne by the AMC. They will be billed to the AUM of the fund. It may either be billed directly or may be reduced from the NAV. The net impact is the same; you as a unit holder pay the cost of running and managing the fund.

We reduce your risk by diversifying…

Again this is a common claim by many mutual funds. Loosely interpreted, most mutual funds tend to equate holding more stocks with diversification. That is not necessarily the case. Diversification happens when the mutual correlation among the assets held is low so that bad times do not coincide for all stocks in the portfolio. More than the number of stocks it is the correlation among stocks that matters the most. Otherwise you are not reducing risk. On the contrary you are only substituting one form of risk with another.

This is exactly where an evaluation of the portfolio becomes critical to understand the nature of diversification that they are talking about. Take the case of a diversified equity fund that is heavily exposed to commodities or heavily exposed to export oriented stocks. In both the cases a negative news flow globally can make the fund an underperformer. This is, although, the fund is technically diversified. Hence, one needs to read between the lines to understand the real nature of diversification.

Be careful of the financial planning pitch…

It is quite common for mutual fund to take the financial planning route. Fitting various mutual fund schemes into a financial plan is the classic pitch where investors must read between the lines. You do not want to plan your 40-year future with a focus on schemes of just one AMC. That is the job of a broker or your financial advisor who has a perspective of a cross section of assets. The mutual fund sales pitch should not be allowed to hijack your overall financial plan.

The moral of the story is, “Read between the lines”. As a smart investor it is in your hands to understand what the sales pitch actually means. Listen to the pitch, do your own homework and only then should you decide on your next course of action.

Compare best performing mutual fund schemes at Religare Online and invest your money smartly.

For all your mutual fund queries SMS ‘ASKMF‘ to 575758 and we will get back to you.

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