Mutual funds sahi hain, but...

Mutual Funds | Representative image
A rising stock market always leads to rampant mis-selling. And ultimately the investor is left with a bad taste in his mouth. Recently, Rohit Karna, a Patna-based businessman, received a call from a mutual fund agent wanting to sell him a balanced fund. "The fund will give you a 12 per cent tax-free return per year," said the agent. Incidents of mutual funds being sold based on promises that are not entirely true are becoming quite common, especially in smaller towns. Retail investors need to do their own fact-finding before falling for fact-finding.

In 2017, the returns from equity and equity-oriented hybrid funds have been high. Fund inflows, especially from retail investors, have been buoyant. Inflows from smaller towns are also rising. However, amid these bullish conditions, a lot of mis-selling is also taking place. Recently, the Securities and Exchange Board of India (Sebi) asked the industry to tone down its 'Mutual Funds Sahi Hai' ad after it received complaints that the campaign is being used to mis-sell mutual funds, especially in smaller towns and villages.

 

Mis-selling of balanced funds (or equity-oriented hybrid funds) is rampant today. These funds are being sold as products where investors can earn 1 per cent tax-free dividend each month. "Investing in a balanced fund that is being sold as a regular income product offering monthly dividend is not the right way to invest," says Jimmy Patel, managing director and chief executive officer, Quantum Mutual Fund. Since the markets have been doing well, agents and distributors are able to show a track record of payouts by these funds. But the full facts are not conveyed to investors. "Dividends can only be paid out of the profits generated by a fund. As soon as the markets witness a downturn, these returns will stop," says Deepesh Raghaw, founder, PersonalFinancePlan.in, a Sebi-registered investment advisor (RIA). Many retirees, who are dependent on their investments for generating their monthly cash flows, are switching to balanced funds. 

 

Mis-selling is also taking place in the mid- and small-cap fund categories, where returns over the past year have been extraordinarily high (category average returns are 45.09 per cent and 57.90 per cent respectively). "Expectations are being built among investors that such returns can continue. It is being said that as the economy recovers, the returns can only get better," says Vishal Dhawan, chief financial planner, Plan Ahead Wealth Advisors.

 

Earlier, with longer duration debt funds doing well, some level of asset allocation was being done to debt funds also. But now that their past returns have fallen, investors are being asked to put that money into credit opportunity funds or equity funds. Both are higher-risk categories that may not be suitable for many conservative investors.

 

Investors clearly need to understand the risks in mutual funds. "Balanced funds have a 65-80 per cent allocation to equities. Their returns can fall sharply in case of a market downturn," says Dhawan.

 

Mid- and small-cap funds are far more volatile than large-cap funds. When the markets correct, the drawdown in these funds can be sharp. A one- to three-year horizon, at a time when valuations of these stocks are sky high, could expose investors to the risk of losses. They should have a horizon of at least seven to 10 years. Allocation to these funds should also not exceed 25-30 per cent of the equity portfolio.

 

In debt funds, investors should not move into credit opportunity funds unless they have the risk appetite for such funds. Putting money withdrawn from debt funds into equity funds could make their portfolios too equity heavy. At this juncture, most investors should have around 60-70 per cent of their debt portfolio in shorter duration funds whose risks are lower.

 

Finally, investors need to do comprehensive research before investing in mutual funds. "If they can't do so themselves they should seek professional advice from a Sebi-registered investment advisor," says Patel.