Category Archive : Mutual Fund Concepts

segregated portfolios in debt funds

Side Pocketing or Segregated Portfolios in Debt Funds

There has been a lot of chatter currently on news channels and various other sources regarding this Side Pocketing or Segregated Portfolios in Debt Fund. Let’s understand what this exactly is.

In the last 3 to 4 months lot of defaults have started happening esp. due to NBFC crisis. In fact, lot of downgrades have happened in the last 1 year. Because of these downgrades or these credit events, a lot of debt funds have gone down on their NAV’s particularly. This has never been seen before. Earlier it could be seen that these debt funds (like credit funds and accrual-based funds) would keep growing slowly and continuously. And people were comparing these debt funds with fixed deposits. But they were only comparing it on the returns part or the taxation part and not on the risk factors involved in that.

Now, SEBI has allowed these debt funds to have segregated portfolios.

Segregated Portfolios-10

Let’s understand what segregated portfolios are,

For example, assume that a fund’s NAV is Rs. 50. And in this Rs. 50, investment papers worth Rs. 2.50 have been downgraded or default has happened. Normally, if the fund has to take a hit, then the NAV would go down to Rs. 47.50. The fund was holding the Rs. 2.50 as well, but AMFI reported the NAV as Rs. 47.50. In this case, investors thought that their investment has gone down from Rs. 50 to Rs. 47.50 and they will never get back the amount of Rs. 2.5, so it is kind of a booked loss for them.

And suppose that after a year the downgraded company gets a revival and is able to repay the money to the fund. Thus, the investors of the fund at that time will get the benefit of the Rs. 2.50. So, the investors who suffered when the NAV became Rs. 47.50 will never get back their money.

Therefore, to avoid this, SEBI has allowed this kind of debt funds to segregate these portfolios. In such a case, a fund A (assume the name just for example) having NAV of Rs. 50 will now have NAV of Rs. 47.50. And SEBI will now allow them to segregate the portfolio calling it as Fund A1 (assume the name just for example) with the NAV Rs. 2.50. So, now the investor will get equal number of units of fund A1 as of fund A. The investor will be allocated will the corresponding number of units if the investor has invested in that fund at the time of default. Thus, if and when that money comes back, the investors will get back their investments. And if an investor exits without segregated portfolios, then the investor books that Rs. 2.50 as loss, which is not a good idea.

Need for Side Pocketing or Segregated Portfolios in Debt Fund

In the last 3 to 4 years a lot of fixed deposit investors have shifted to debt funds expecting similar and steady returns from these debt funds, which is not happening in the past 1 and half years because of the defaults and also because of the interest rates going up.

When the NAV’s of debt funds go down because of defaults, the retail investors panic and exit these funds. But this is not the right action to take.

Therefore, to safeguard the investors SEBI has allowed debt funds (or money market funds) to segregate these portfolios or side pocket these portfolios and allocate additional units in the new fund. Hence, the investors in this fund will have some hope that the money lost will come back to them only.

So now, even if the investors exit, they exit with NAV of Rs. 47.50 and have the rest of Rs. 2.50 as a segregated portfolio and get that money back if and when the recovery happens.

Thus, side pocketing or segregated portfolio in debt funds is fair to all deal, a win-win situation for everyone. Therefore, this a very good step taken by SEBI.

5 Most common Mutual Fund Myths: Busted

Mutual Funds are collective investment instruments that are regulated and sold to the general public. They are managed by professional fund managers who invest the fund’s capital and attempt to produce capital gains and income for the fund’s investors.

Mutual Fund Review E-Books with unique Yadnya Methodology
Detailed Mutual Fund Review E-Books (Analyzed With Unique YADNYA Methodology)

The main myths about investment in mutual funds are as follows:-

1] There is a lot of documentation required

KYC (Know Your Customer) is just a one-time exercise and the process can be completed through a SEBI- registered intermediary (broker, Depository Participants (DP), mutual fund agency, etc). You need not undergo the same process again while approaching another intermediary. As per the KYC requirement, you need to submit an identity proof, address proof and latest photograph to invest in mutual funds/securities markets. KYC is mandatory to invest in mutual funds. Just like a combo ticket to an entertainment park makes it easy to enjoy all the rides, doing KYC one-time allows you to invest in all mutual funds hassle free.

2] You need a Demat account for Mutual Fund Investments

Mutual Fund investors are free to receive the units either as a physical statement or dematerialised form. Thus, it is not mandatory to have a demat account for investing in mutual funds. If you are a first-time investor in mutual funds, you need to fill up a Know Your Client (KYC) form and submit it along with your application form. You will also have to submit other relevant supporting documents. Once your KYC documents are verified, your investment will be accepted.

3] It is difficult to exit mutual fund investments

Another myth which stops investors from investing in mutual funds is that they think starting SIP for X yrs, is a commitment they can’t break in between and they will face some penalty if they stop their investments. But, the truth is that once the SIP is started, it can be stopped anytime in between. So, don’t worry while starting the SIP for next 5, 10, 15 or 20 yrs. The day you want to stop it, it can be stopped with just one notification.

4] You need a big amount for investing in mutual funds

There is the most common myth. A large section of investors believe that they need a huge amount of money to invest in mutual funds. Where as, in reality it is just the opposite. One can invest as low as Rs. 500 per month via Systematic Investment Plan (SIP) and Rs. 5,000 through lump sum mode. Also, there is no monthly or annual maintenance charge even if you don’t transact further.

 5] Mutual funds are meant for the long term

When someone suggests a mutual fund, the first question asked is whether it is “long-term ” investment. The fact is it’s good if you invest for a very long term as you can reap the benefits of compounding. But, one who needs money sooner can also invest with a view of getting the better return than other asset classes. There are multiple schemes to choose from those suit different types of investors. Mutual funds are useful for every investment purpose, be it short-term, medium term or long term. While Liquid and Short-term Debt funds are suitable for short and medium-term requirements, Equity funds are ideal for long-term needs.

You can also read are article on why mutual funds are better than direct stocks – Why Mutual Funds and Not Direct Stocks?

Why Mutual Funds and Not Direct Stocks?

According to the report (till 2017 data) by Economic Times, it revealed that only about 4.5% of the total market capitalization in India is held through mutual funds. But, direct stock holding by individuals is nearly 22% of the market capitalization. This shows that the practice of directly investing in stocks is more favorable to a select group of Indians with strong purchasing power.

Choosing between the two kinds of investments depends on a person’s risk taking ability. It also depends upon return expectations and the ability to manage a share portfolio. The recent years have seen a lot of investors move from direct stocks. An increasing percentage of the average Indian population is turning towards mutual funds.

Here are a few reasons to buy mutual fund instead of stocks:-

1] Affordability –

Generally, to have a well balanced portfolio, you would need to have about 25-30 stocks in your portfolio. This can lead to a good mix of performance and stability. Such an approach can be achieved if you have a large enough corpus. As an individual, you may not have enough funds to create a adequately diversified portfolio of stocks. Mutual funds provide instant diversification. You receive diversification benefit without investing a huge corpus when you buy units of the mutual funds that are spread across several stocks.

For example, if you want to buy 1 stock of Maruti Suzuki India Ltd, you will have to spend Rs 9701 (closing as on 23rd July 2018). But if you buy a Mutual Fund which has allocation to Maruti Suzuki India Ltd stock, you can do that with for just Rs 500 as well.

2] Flexibility –

With stocks, you have to open a DEMAT and a share trading account. You have to do complex analysis on companies and sectors. This analysis has to be done to understand which stock to buy, know when to sell stocks, pay commission on each trade you make, and more. It is very convenient to invest in mutual funds.  Everything gets done for you for a very small management fee. Online platforms make it even easier to invest in mutual funds. They do fund selection, annual portfolio review, automated investments and more, completely online. Exiting mutual funds at any time is very easy. Mutual fund redemption procedure is quick, simple and transparent. Switching between funds can also be done in mutual funds.

3] Transparency –

Mutual funds industry is regulated by SEBI. SEBI oversees the functioning of all the security exchanges’ in India and sees to it that there are no malpractices performed. The stocks and bonds that a mutual fund invests in are publicly available every month, so if required, you can see what your fund manager is doing. A good fund management company should make all the information on funds and their functioning, available to an investor in the form of factsheets, portfolio statements, etc. on their website.

By the instructions given by SEBI, AMC’s do the following things:-

  • Transparency in purchase and sale price: – NAVs are declared and published on daily basis.
  • Transparency in portfolio of fund: – AMC’s disclose their portfolio details at regular intervals and investors can view the portfolio of the fund they have invested in.
  • Transparency in investor’s account: – Simple one pager account statements are sent to investor

4] Expert Fund Management –

Thorough research on companies and on the industry is required before investing in stocks. Whereas, mutual fund houses have professional fund managers along with a team of analysts to do all the research before picking the right stocks. They keep tracking them and use their skill sets to derive higher returns and mitigating the risks. Keeping watch on performance of every stock in your portfolio is not possible for every investor. Whereas, professional fund managers of mutual funds do this for you.

5] Diversification –

Mutual funds are based on the concept, “don’t put all your eggs in one basket”. This is known as diversification.

It requires good amount of money to create a good diversified stock portfolio. This limitation of stock investment is overcome by mutual funds. This is so because mutual funds receive money from public at large. This money ranges from a very small amount say Rs 500 to a large sum of a crore or more. This gives mutual funds huge power to invest in stocks across categories. This is by far the best advantage one can see of mutual fund investments.

But simply purchasing a mutual fund might not provide with adequate diversification. It’s crucial to check if the fund is sector specific or industry specific. For example, investing only in a technology and IT mutual fund might spread your money over fifty companies. But if stock prices of those stocks fall, your portfolio will suffer.

why mutual funds and not direct stocks

Factors to Analyze While Selecting a Mutual Fund

factors to analse while selecting a mutual fund(10)
How to choose a Mutual Fund?

An investor should analyze the following important factors of a mutual fund before selecting it:-

1] AUM of the Mutual Fund–

Assets under management are the overall market value of assets/capital that a mutual fund holds. AUM is an indicator of the size and success of a fund house. One can easily compare its assets under management in various timelines and market phases performed as opposed to its peers. The AUM-value also includes the returns that a mutual fund earns. The asset manager can invest this in securities, distribute to investors as dividends or hold as per the investment mandate.

You should avoid funds with too low AUM as that would mean less inflows and less focus from fund house.

2] Alpha of the Mutual Fund–

Alpha measures the difference between a fund’s actual returns and its expected performance given the level of risk. It indicates the risk-adjusted performance of a portfolio.

It takes the volatility (price risk) of a security or fund portfolio and compares its risk-adjusted performance to a benchmark index. The excess return of the investment relative to the return of the benchmark index is its “alpha”. Alpha is often considered to represent the value that a portfolio manager adds or subtracts from a fund portfolio’s return.

3] Mutual Fund Portfolio P/E Ratio –

In mutual funds, the PE Ratio multiple of a scheme is arrived at by using a weighted average of underlying stocks. A high portfolio PE would show that the scheme mostly holds stocks that are quoting a valuation premium. This indicates a preference for growth oriented businesses.

But, if the PE of the mutual fund is on the lower side, it signifies a value-conscious approach. Growth oriented funds tend to exhibit strong returns within a short span of time but are more volatile. Value conscious funds typically yield great results over a longer period of time and come with lesser volatility in returns.

4] Beta –

Beta measures the sensitivity of a portfolio against its benchmark, which can be in the range of 1, >1 or <1 for equity funds, wherein 1 indicates fund’s NAV will move in same direction as that of benchmark index and that of less than 1 indicates the fund’s NAV would be less volatile than the benchmark index.

Beta is a risk ratio that investors use as a tool to calculate, compare and predict returns. It utilizes benchmark indexes, such as the BSE Sensex. And compares them against the individual security to highlight a particular performance tendency. Beta is based on the volatility in prices or trading, of the stock or fund, something not measured by alpha. But beta, too, is compared to a benchmark.

5] Mutual Fund performance –

The performance needs to be considered because it gives you an idea of how it has handled money in the past over a period of time. Ensure that you measure the performance over a significantly long period so that you know the pattern and can make a good judgment. You may want to look into what kind of risks the fund has exposed you to over a period of time.

Performance can be considered as a scorecard of the past behavior of the scheme. In mutual funds, performance analysis depicts the results of the fund managers’ skills and caliber in outperformingthe benchmark returns. Thus, the funds with consistency in performance and high-risk management during volatility in the market are best suitable funds for the long-term investment.

6] Mutual Fund Sharpe Ratio

Sharpe ratio measures the extra return a fund has generated relative to the risk taken. The higher the sharpe ratio, the better a fund’s return in lieu of the risk.

It is calculated as,

Sharpe ratio = (Return of the fund – Risk free rate of return) / Standard Deviation

Sharpe ratio is a measure of excess portfolio return over the risk-free rate relative to its standard deviation. If two funds offer similar returns, the one with higher standard deviation will have a lower Sharpe ratio. To compensate for the higher standard deviation, the fund needs to generate a higher return to maintain a higher Sharpe ratio.

7] Exit load –

Exit load is another cost that you directly incur. It is a fraction of the NAV that you receive and thus, leaves a hole in your investment value. So, the lower exit load a fund offers, the better is it for you. It only comes into play if you wish to sell your units.

8] Mutual Fund Manager Information –

A good fund manager helps create a strategy that can deliver better risk adjusted returns for the fund scheme within the mandate. But, a fund that delivers only because of the presence of a particular fund manager is unlikely to sustain its performance in the long term.

The experience and tenure of the fund manager play significant role in the performance of the fund and its returns generating capability. Moving the capital in the right possible way by predicting the various future market trends is not a simple task. They have to keep their eagle’s eye on the continuous behavior of the market to grab the best opportunity to fetch more returns. So, you should know a little detail about the fund manager of the scheme and his/her records of excellence. You can also check the performance of other schemes which are being managed by the fund manager. This provides with more clarification of the expertise of the fund manager.

Over the long-term, it pays to have your money managed by a group of fund managers, rather than one star fund manager. As he could quit the fund house any time and take the performance with him.

9] Expense ratio –

This is usually considered when you invest in anequity fund. The higher the expense ratio, the more it affects you directly. It comprises of the brokerage fees and other costs that the mutual fund houses charge from investors. Hence, you need to see if the charges are not over the top. But, there are funds that charge high but make it up by offering a higher NAV or better returns. So consider these also while checking the expense ratio.

Expense ratio is the very important parameter to be looked at before selecting any mutual fund scheme.

10] Standard Deviation –

Standard deviation tells you how much have the fund returns fluctuated. It means how far the returns of the fund have deviated from its average over a period of time. More the deviation, more volatile the fund is.

One can use the above-mentioned factors as a checklist for next time you choose a mutual fund to invest in.

Below is a photo of a fact sheet of HDFC Equity Fund as on May 2018. The fact sheet is used just an example.We are neither promoting the fund house nor the fund.

HDFC Equity Fund May 2018 FactSheet 1st half
HDFC Equity Fund May 2018 FactSheet
HDFC Equity Fund May 2018 FactSheet 2nd half
HDFC Equity Fund May 2018 FactSheet

Features of Liquid Fund

Liquid Funds are open-ended debt mutual funds that primarily invest in short-term money market instruments with maturity up to 90 days.

Liquid mutual funds invest in money market instruments such as Certificate of Deposits (CDs), Commercial Papers, Term Deposits, Call Money, Treasury Bills, etc.

Given below are the features that liquid funds provide:-

1] 1 Day Liquidity –

Liquid fund withdrawals take place in a very short time, usually within a span of 24 hours.

2] No Entry or Exit Loads –

Liquid funds have no entry load and exit loads. Sometimes exit load is charged if redeemed before the lock in period.

3] Lowest Interest Rate Risk –

Interest rate risk defines the possibility of change in a bond’s price due to a change in prevailing interest rates. Inversely proportionate, when interest rates go up, most bond prices go down. When interest rates go down, bond prices go up.

Given that liquid funds mainly invest in fixed income securities which have a short maturity period, they have one of the lowest interest rate risks as compared to other debt funds.

4] Immediate Liquidity up to 50K –

SEBI has recently mandated that AMC’s should allow instant redemptions of up to Rs. 50,000 from Liquid Funds. Asset management companies (AMCs) will offer instant redemption of Rs 50,000 or 90% of the folio, whichever is lower, in liquid funds.

Some funds that provide instant redemption facility are listed below:-

  1. Reliance Liquidity Fund
  2. DSP Blackrock Liquidity fund.
  3. Aditya Birla Sun Life Liquid Fund
  4. SBI Liquid Fund.
  5. ICICI Prudential Liquid Fund.
  6. Axis Liquid Fund
  7. HDFC Liquid Fund

 5] Lowest Credit Risk –

Unlike typical bank fixed deposits or savings accounts, liquid mutual funds are not insured. Even though money market mutual funds invest in high-quality securities and seek to preserve the value of your investment, risk is inevitable. There is no guarantee that you will receive the invested capital when you redeem your units.

6] No Lock-in Period –

They are known as liquid funds as they have no lock-in period and give you quick access to the cash by redemption.

features of liquid funds.png

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