Choosing your Mutual Fund
The last few weeks saw one of the worst periods in the Indian Financial markets. The sentiments in all the markets were bearish. Sensex went below the 4000 mark, the rupee touched all time lows against the dollar and consequently the RBI was forced to take some liquidity tightening measures by increasing the interest rates. In fact, the high short term yields in the money markets produced a inverted yield curve last week, when the yield on 90 day T-bill was fixed at a higher level than the 364 day T-bill by the RBI.
In such a scenario, a naive investor must be wondering where to put his hard earned savings. The equity market is clueless and the traditional avenues, although they are relatively less risky, provide meager yields. So the only choice that comes to the minds of investors at large is the Mutual Funds (MFs). These MFs provide an advantage of diversification of risk and the professional expertise of Fund Managers.
Now the question is, in which category of MFs to invest, equity or debt or balanced. Equity funds are relatively more risky because of the uncertainty and volatility in the equity markets. In today's scenario, when the interest rates are rising, most of the bond funds are facing the brunt because the increased interest rates have pulled down the prices of most of the bonds and their portfolio has come down in value. There is no clear cut direction the interest rates might take in the future. So even the bond funds have become more riskier in such a scenario. This leaves only the balanced funds. Let us take a closer look at these balanced funds.
Balanced funds are those funds, which invest a certain percentage of their corpus in equity and rest in the bonds. This gives the benefits of both the equity investment and fixed income investment. In today's scenario, it would be best to invest in a balanced scheme of a MF. The reason being, investing in such a MF would give the benefits of diversification across the class of securities. After the introduction of index futures, it has become easier for the MFs to hedge themselves against the market risk. But even that hedge works upto a certain point of time, so the exposure to the equities should be limited. Also, there are balanced funds that takes more exposure to certain sectors, like some Indian MFs were doing trying to ride the ICE boom. But such funds are again more riskier because the returns from such funds depends upon the performance of a particular sector.
The investment in bonds assures a steady stream of income without taking the entire risk inherent in the bond funds. Again, in today's scenario, where the direction of interest rates is clueless, one should not take excessive exposure to bonds market. Thats why a balanced fund is an ideal investment in today's scenario. A quick look at the returns from the schemes of two of the MFs would put the things in a better perspective.
The three month return from DSP Balanced Fund works out to be 6.47%, where as the return on DSP Equity Fund works out to be 5.85% over the same period and for DSP Bond Fund, it works out to be 0.20%. So, one can see that the balanced fund has provided the maximum return over the last three months. Similarly, the 3 month return on Magnum Balanced Fund is 9.34% whereas the return on Magnum Equity Fund is 8.50% over the same period. And this is true for most of the funds.
Usually, in rising markets, the returns on equities tend to be higher than other investments but they also carry the maximum risk. And now that the SEBI has put a 16% circuit filter, they have become all the more riskier. A Balanced Fund provides the benefits of equity investments with limited risk and also a steady stream of income.
Therefore, in today's market scenario, one should invest in a Balanced Mutual Fund which is not having considerable exposure to any particular sector. But an investor needs to keep certain basic rules in mind while selecting balanced funds. Firstly, avoid funds where the equity component is heavily skewed in favor of limited sectors. Secondly, avoid funds where the debt component of balanced funds has an average maturity of beyond 2 years. Thirdly, timing is very important. Currently, the equity markets are substantially corrected and the debt markets hold good promise due to higher interest rates which virtually diminishes the prospects of bond value depreciation. So go ahead and invest in balanced funds, but do your homework well in advance.
Rajneesh Mittal