How to Select Equity Mutual Funds
Dear novice investor,
Before I delve into an analysis of individual plans, let me say a few words about money.
A. First Principles:
You're the best money manager for your money.
Nobody can take care of your money better than you.
Don't believe anyone when it comes to your money.
The financial world works on incentives for their own gain, client interest comes last for banks and other financial companies that recommend all kinds of financial products, like mutual funds and insurance plans. This is a brutal reality.
One of the best ways for wealth creation is nurturing one's own human capital, which is more beneficial and fulfilling than earning higher returns from one’s investments. This is the opportunity cost of your time.
B. How to invest in direct plans:
There are several ways to invest in direct plans of diversified mutual funds in India. Direct plans means you're investing on your own, without any broker or intermediary. If you invest through brokers, they're called regular plans and brokers get commission from them when you invest in regular plans.
Direct plans have lower expense ratio, as compared to regular plans--the difference works out to 70 to 150 basis points (100 basis points equals one percentage point) per year in general--which means over period of 15 to 20 years, accumulation from direct plans will be greater. Past data prove this point.
You can visit service centre of the individual asset management company (AMC) or Mutual Fund to invest in direct plans. While applying, you better tick the box "direct," and strike out the broker/intermediary box. AMC is the mutual fund company that manages the investment on behalf of customers / clients.
Before you start investing in mutual funds, you need to do KYC (know your client) documentation. This is a one-time task. Once you complete KYC for a mutual fund, the same KYC-MF can be used for investing in other mutual funds.
If your KYC-MF (know your client - mutual fund) is already done, you can visit the AMC website and start investing in direct plans. It seems some funds insist on visiting their service centres physically when you're investing for the first time with their AMC. With some AMCs, you can invest online by visiting the respective website.
Before investing in the funds of an AMC, you could check their service level and quality. While some AMCs provide seamless service, some are not so good.
However, after investing for the first time with an AMC, the subsequent investments will be more or less smoother. You can take login from the AMC and do online transactions (like buy, sell, change of email, change of phone and others).
KFinTech Pvt Ltd provides MF services for direct plans, they have more than 20 AMCs. The web link is: KFinTech
Another option to invest in direct plans is using CAMS Online website. They allow investments in 16 AMCs. The web link is: CAMS online.
Once you start investing in mutual funds, you will receive a monthly statement from NSDL (it's called CAS or consolidated account statement) directly to your registered email as long as you invest in that particular month. NSDL is National Securities Depository Limited, which maintains electronic records of shares and mutual funds in India.
NSDL is regulated by the Indian government and SEBI (Securities and Exchange Board of India), which regulates mutual funds in India.
Various other options too are available to invest in direct plans--such as Kuvera, Groww, Coin by Zerodha and Mutual Fund Utility (AMFI sponsored)--but I've not used any of them. AMFI is Association of Mutual Funds in India, a body of the mutual fund industry in India.
Overall, you can invest in direct plans through AMC websites or KFintech Online or use CAMS Online. (They give a lot of publicity for downloading their mobile apps. But I'm not comfortable with these mobile apps--because Indian firms aren't good in cyber security).
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Related articles:
Best equity mutual funds 21Sep2011
Diversified equity mutual funds 18Jun2010
Diversified equity mutual funds Scribd 18Jun2010
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C. General Principles:
Direct plans have lower expense ratio, as compared to regular plans--the difference works out to 70 to 100 basis points per year in general--which means over a period of 10 to 15 years, accumulation from direct plans will be greater. Past data prove this point.
(Not that you're are unaware of these things--but it's better to keep them in mind while investing.)
A few years ago, I did a brief analysis of the difference between direct and regular plans of mutual funds. This analysis is available here: Tweet thread 22Jan2018.
It's better to choose Direct Plans and Growth options. Better to opt for growth options (don't opt for dividend option) if you want long term growth. Direct plans carry lower expenses (the assumption with investing in direct plans is the investor is capable of choosing mutual funds on his/her own). Direct MF plans don't pay any commission to agents/advisors. (This means you should not opt for Regular plans, which charge higher fees).
In general, equity MF plans with higher exposure to mid/small-cap stocks carry higher risk, as compared to large-cap oriented plans. Mid-small cap funds give more returns in bull markets and they fall more in bear markets. In general, large cap funds (and to some extent flexi cap funds also) provide long term return and stability.
If you see large cap funds, they too hold some percentage of mid-cap stocks. Flexi cap funds too hold a substantial part in mid-cap stocks. When you consider mid-cap funds, keep this point in mind.
Don't consider one-year returns. Consider long term returns versus risk. Some funds take more risk and give more returns; but such funds tend to fall very much during market crashes as we have seen in 2008. Please see whether they're offering downside protection during bear markets, for example, in 2008, 2011, 2018 and 2020 and any other periods of severe market fall.
You can see holdings style box, Sharpe ratio and standard deviation--among risk measures.
Please see whether the plans are charging exit load. Entry load was banned by SEBI in August 2009.
While investing, don't forget to opt for nomination facility.
It's not a good idea to hold more than three or four schemes in your equity mutual fund portfolio. To start with, three equity plans are enough. The three plans need to be diversifying among themselves--in terms of their investment strategy, portfolio diversification, geographies invested (e.g., you can choose a fund that invests in foreign securities, without foregoing equity MF tag for tax benefits), fund house philosophy, and others.
Each mutual fund plan invests in 40 to 60 stocks, providing diversification. As such, there is no point in investing in more than two or three mutual fund plans. Two or three mutual fund plans provide reasonable diversification across stocks, sectors, and themes.
Investing is basically a forward-looking approach. Past record is only a guide.
Please check their long term performance before investing. After investing, check their performance at least every quarter or half-year. There are various websites to analyse and track the performance of mutual funds. You can see Value Research and/or MorningStar India. Various other websites are also available.
As the salaried class invest through systematic investment plans (SIPs), one could calculate SIP returns for MF plans before investing (rolling returns can be considered for different 5-year periods for better comparison across plans).
Some fund houses change fund managers. As performance of active funds depends primarily on fund managers, it's better to watch for changes in fund managers. You can also check performance of other funds managed by the same fund manager.
Some plans hold higher cash holdings of 10 to 20 percent in their portfolios. In up-trending markets, such funds give lower returns and vice versa.
After investing, you can create your own portfolio in Value Research Online. Actually, if you can upload all your equity MF investments in Value Research in a single portfolio, the analysis will be good. You can also use it for adding your investments mutual fund SIP, stocks, bonds, fixed deposits and other investments.
D. Large-cap and flexi cap equity mutual fund plans:
While selecting equity mutual fund plans, you can consider large-cap and flexi cap plans -- all with growth options and direct plans. You can consider only those plans where the fund manager has been managing the fund for at least four or five years. You can ignore plans of smaller fund houses, such as, Mahindra, IDBI, ITI, Navi, Motilal Oswal, etc.
You can check SIP returns of several mutual funds to compare their returns.
You can check SIP returns for three-year and five-year horizon, since people with regular income are expected to invest in mutual funds through SIP (systematic investment plans) route.
Selecting funds on a forward-looking basis is hard. However, conservative investors usually look for stability, consistency and AMC's overall track record.
F. To Sum Up:
1) It's better to choose direct plans and growth option plans. Opt for direct plans if you've the ability and time for analysing the funds.
2) Check the past performance thoroughly before investing, but past record is only a guide.
3) It's better to select three large-cap or flexi cap equity plans. At this point of time (with Sensex around 53,000 today), risks are a bit higher. But first-time / novice investors need not worry about entry point. For them, any time is a good time.
4) Timing the markets is extremely hard, hence it's better to stick to one's asset allocation and investment plan; and stay invested with long term orientation and patience.
5) One could choose three different funds from three different fund houses (concomitantly, avoiding selection of the same fund manager or plan from the same fund house).
6) Finally, investigate before investing and don't forget to track after investing.
Happy investing!
Rama Krishna V.
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P.S.: The following news items are added after the above article was published on 19Jul2021:
23Sep2021 Value Research - CAMS and KFintech, the two biggest RTAs in India, have jointly developed MF Central MFCentral with the support of depositories and AMFI, as a unified hub for investors - CAS - MFCentral FAQs - mutual fund portfolio all at one place - SEBI circular 26Jul2021 for a common industry platform - MF services - mutual fund statement -
Disclosure: I've vested interested in Indian stocks and other investments. It's safe to assume I've interest in the financial products discussed, if any.
Disclaimer: The analysis and opinion provided here are only for information purposes and should not be construed as investment advice. Investors should consult their own financial advisers before making any investments. The author is a CFA Charterholder with a vested interest in financial markets. He blogs at:
https://ramakrishnavadlamudi.blogspot.com/
Twitter @vrk100
