Perils of investing in mutual funds directly | Firstpost

By Srikanth Meenakshi

Starting January 1, 2013, mutual fund investors in India will be able to invest in the so-called ?direct plans? of mutual fund schemes. These plans will be available when a person invests directly in a mutual fund company, without going through an advisor or an investment service.

The benefit will be that these plans will charge a lower expense ratio compared with the regular plans. Although the actual quantum of difference is not known at this time, speculation is that it would be between half a percent to one percent for equity funds, and less than half a percent for debt and liquid funds.

Should investors opt for these plans? Over the long run, will they stand to gain from choosing this method of investments? What will be the implications of doing so? To answer these questions, it is necessary to look at some current facts and analyse them logically.

Importance of choosing good funds

The universe of investible funds is large ? just in the equity funds space, there are upwards of 200 funds to choose from. Including debt funds, the total set of funds available for investments is upwards of 1,500. A regular investor needs not more than 7-10 funds in their portfolio even if they are investing for multiple time-frames, financial goals etc.

Given this, the danger of choosing a wrong fund is more dire than choosing a more cost-effective ?mode? of investing. Looking at data, we can see that over the past periods of investments, there are significant gulfs between the best and the worst performing funds.

For a 10-year period, the gap is 23 percent per year! For a five-year period, it is more than 28 percent (see images below)! In fact, an investor over the last five years, would have lost money significantly with imprudent choices rather than making a reasonable, if relatively low, returns.

Source: FundsIndia.com

Source: FundsIndia.com

Obviously, in this situation, choosing good funds makes a bigger impact than cost savings of a few fractions of a percentage point. But does advice really make a difference enabling investors to choose good funds? To try and answer this question, again, we turned to data.

Value of advice

It is not as if this avenue of investment has been newly made available to investors. They have always had the option of investing directly with the mutual fund companies without the help of any investment service. There is even a mutual fund company ? Quantum AMC ? that gets most of its inflows directly from investors.

However, as per current industry statistics, only a very small fraction of investments come through in this direct route. Even if one looks at only retail investments that are predominantly in equity funds, less than 7-8% of the assets under management have come directly from the investors to the mutual fund schemes.

We were curious to see if there is a correlation between getting advice and investing in good schemes. Although one cannot get exact statistics on the performance of advised investments versus direct investments, we found a couple of data points that strongly support the hypothesis that a majority of investors today have done well with their investments.

If one looks at the five-year performance of all diversified equity funds, there have been 163 funds in this period. Of these 117, or 65% have beaten their respective benchmarks. However, the total AUM of these 65% of funds is significantly more than 65% of the AUM that is spread out among all the 163 funds. In fact, it is as high as 91%!

If one looks at the same figures for a three-year time frame, the numbers are similar ? 74% of the funds that have beaten the benchmark?s performance have 90% of the total AUM.

Though it does not prove it, this strongly suggests that retail investors today, who are overwhelmingly investing through advisory services, have done well with respect to their investment choices. They have invested in funds that have performed well rather than in lesser funds by a significant margin.

Can Investors do it themselves?

This leads us to the third question. Is choosing funds that hard? Can the investors make these choices themselves? On this question, it is tough to find hard statistics to answer this question one way or the other. However, going by anecdotal evidence and experience, I would be inclined to answer the question in the negative.

Source: http://www.firstpost.com/investing/perils-of-investing-in-mutual-funds-directly-533020.html

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