Access to financial markets is rapidly expanding in India, and many first-time investors are choosing mutual funds as a safe and convenient way to put their money to work in the market.
The Association of Mutual Funds in India (AMFI) reports assets under management in Indian mutual funds grew fourfold to INR 25.49 trillion over the last decade.
To help investors get a better understanding of the way mutual funds work in India, we spoke to experts.
Why Choose a Mutual Fund?
Investors choose mutual funds for a range of reasons, from easy diversification to the potential to protect your investments from inflation. Here are some of the main reasons to buy mutual funds:
Mutual Funds Are Easy to Access and Easy to Understand
A mutual fund is a professionally managed, regulated investment fund where money from retail and institutional investors is pooled together and invested in a range of different assets. They give you the ability to make investments in the capital market in whatever amount suits you. Mutual funds invest in equities, bonds and commodities, and other types of securities. Mutual funds let investors manage risk and get diversification.
Mutual Funds Help You Build Long-Term Wealth
Mutual funds help generate sustained, long-term gains. Investors can make any size of investment, as low as INR 500, into mutual funds and that money has the potential to be compounded over the long term. Shorter-term investments are marked by greater volatility.
Mutual Funds Help You Beat Inflation
Equity mutual funds in India have had higher chances of beating inflation compared with other asset classes. On average, Indian equity mutual funds have gained 10.6% percent over the last 10 years if tax-saving equity plans are considered. With Indian inflation averaging 7.3% in the 2010 to 2019 period, and 6.6% in the first half of 2020, mutual fund investors have seen a real rate of return between 3% to 4% a year. As you can see, mutual funds can help you beat inflation.
Equity funds are a better choice than low-risk financial instruments such as bank fixed deposits that don’t factor inflation year-on-year or the Public Provident Fund (PPF), which faces the same challenge.
Even in bond mutual funds and hybrid mutual funds, an investor has a good chance to earn long-term returns than beat the average rate of inflation. And these types of funds are less risky than equity mutual funds.
Mutual Funds Are Heavily Regulated
The Securities and Exchange Board of India (SEBI) regulates mutual funds. The AMFI publishes official monthly, quarterly and annual reports on fund performance, including AUM data, which helps keep investors well informed of how well their investments are performing. Mutual funds go through periodic audits and are expected to satisfy stringent compliance requirements.
What Are the Different Kinds of Mutual Funds?
There are two kinds of mutual funds in India: Stock mutual funds—also referred to as equity mutual funds—and bond mutual funds.
Stock mutual funds are higher risk, higher volatility investments, but they offer greater returns on average. Bond mutual funds invest in corporate or government debt, are less risky, have lower volatility and offer generally lower returns. However, the price of equity mutual funds fluctuates a lot more than the price of debt mutual funds.
They are other kinds of mutual funds that enable investors to have a varied bouquet of asset classes in their portfolio.
The Benefits of Mutual Fund Investments
Mutual funds have been perceived as safer investments than direct equity trading for a range of reasons.
Mutual Funds Limit Volatility
The diversification you get with mutual funds limits volatility. In addition, they satisfy the varying risk/return expectations and investment horizons of investors across the spectrum, explains Piyush Gupta, the Director of CRISIL Funds Research.
If your investment horizon is long enough, volatility can be reduced even in equity mutual fund investments.
“For instance, analysis of holding periods in equity represented by the S&P BSE Sensex since its inception in 1979 has shown that volatility, as measured by standard deviation, falls from 35% in a one-year daily rolling period to 4% for a rolling holding period of 15 years,” says Gupta.
Overnight funds, for instance, are considered the safest variety of mutual fund, since they invest in debt instruments with a maturity of one day, reducing risk from volatility in the underlying market.
Systematic Investment Plan (SIPs) let you invest fixed sums at regular intervals. This gives you the benefit of cost averaging, helping investors further smooth out volatility, says Shantanu Awasthi, the head of products and international business at Karvy Private Wealth.
Protection from Fraud
Mutual funds help address the concerns many Indian investors have about fraud. People’s concern about the safety of their investments comes from the fear of losing money to fraud or market risks, says Bharat Ravuri, managing director of Principal Asset Management.
In India, mutual funds are established as trusts, overseen by trustees that act as independent directors outside of the asset management company or an AMC. Trustees are charged with actively protecting investor interests. Trustees appoint and manage the AMCs that handle day-to-day fund management.
Limited Possibility of Market Losses
SEBI has defined clear limits on exposure of a single stock at the fund level and fund house level. These regulations ensure that single stocks do not define the overall outcome of the fund, says Ravuri.
Investors should have a diversified portfolio of funds to meet different financial needs. This ensures they aren’t subjected to single fund risk, and can benefit from the performance of different funds in varying market contexts.
Strong Regulatory Oversight
Mutual funds are strictly monitored by regulatory agencies SEBI and AMFI. The extensive due diligence conducted before granting licences to operate an asset management company helps make mutual funds safe, says Awasthi.
Funds are generally run by qualified and experienced fund managers. Each fund has a well-defined investment objective, which helps prohibit fund managers from taking unnecessary risks.
There is a high degree of transparency for mutual funds, with data available to all stakeholders. Ravuri cites the daily publishing of net asset values (NAV), monthly reporting of portfolio holdings and publishing regulatory mandated reports and decisions.
Every fund must publish an investment objective and asset allocation, and fund managers are mandated to follow both the objective and asset allocation. Any deviation requires filing with regulators, ensuring fund managers remain true to each fund’s stated objectives.
Why Should Investors Stay Invested Despite Uncertainty
The coronavirus pandemic has caused considerable uncertainty and trends such as investors stopping further investments and redeeming existing mutual funds to enhance cash flows were witnessed.
AMFI data shows that Q1 of 2020 reversed the trend of flows into Indian mutual funds, with net outflows in the quarter of INR 94,267.22 cr. The second quarter of 2020 delivered a rebound, with net inflows inching back by INR 1.24 lakh cr, taking assets under management (AuM) to INR 25.49 lakh cr, although this is still less than the corresponding period a year ago.
Morningstar attributes increased redemptions in June 2020 by investors booking profits as the reason for the stark slump in AUMs compared to last year.
Low Levels Pay Back
Markets are expensive when they are at their peak and cheap when they are down. It is wise to buy at cheaper levels and sell at higher levels is common knowledge.
Gaurav Rastogi of Kuvera.in urged investors on his platform to stay invested despite COVID-19 fears because if an investor was bullish and willing to invest when the market was at 12,000 then why should they stop investing at lower levels of 10,000 or 11,000. Rastogi says Kuvera’s clients are happier they continued their investments now since the market has bounced back significantly.
Equity Mutual Funds Can Turn Game Changers
Karvy Private Wealth’s Aswathi has seen that in times of volatility, the normal response for investors is to reduce the exposure to equity mutual funds or get away from equity mutual funds, but it is important to remain calm during the volatile period and to act on a plan during this time.
Two-fold advantages arise when investors invest during volatile periods: One, the opportunity to invest at lower levels with favourable valuations arises, and second plus is the rupee-cost averaging for previous investments.
While investing in equity mutual funds, investors often set aside a fixed sum to invest at a regular interval, also called Systematic Investment Plan. Rupee cost averaging allows investors to buy more shares when the share price falls in a volatile market for the same sum that they had been allotting monthly.
Awasthi hence suggests a reasonable solution in the current situation, would be to stagger investments over a 3-4 month period and increase allocation to monthly Systematic Investment Plans.
Long-term Translate to Bigger Gains
CRISIL’s Gupta is confident investors can achieve their financial goals by holistic financial planning that factors in investments in mutual funds with a fair idea of risk profile and the investment horizon.
Principal Asset Management’s Ravuri sees opportunity in acquiring a higher number of a stock’s units, which would potentially lead to higher returns in the longer term during the current market volatility and downturn.
They suggest awareness via education and getting a financial advisor can help investors wade through storms of economic uncertainty.