Why investing in mutual funds can sometimes be a hopeless proposition?

Updated: Monday, March 3, 2014, 9:58 [IST]

A couple of years back the Securities and Exchange Board of India (SEBI) was contemplating action against 18 mutual fund schemes for non performance. Their performance was so awful many investors saw their capital erode.

Last year, the Business Standard newspaper reported that only half the large cap equity schemes, outperformed the benchmark indices. This means that if you had invested in the other half, your returns would have been poor. The same newspaper carried a report that over a 15-year period, only three schemes have returned much more than their benchmark indices. To check recent dividends from mutual funds click here

Does investing in mutual fund scheme for long term pay?

There are many investors, who are badly stuck in mutual fund schemes, that have just not performed. They have held onto it for many years and chances are, even if they hold onto it for eternity, they might not get decent returns. The mantra, that it pays to be invested for the long term, can sometimes be a myth. Not always though.

Some mutual fund schemes have a portfolio that comprises stocks, whose share price resurrection is simply not possible. The real problem is that if the share price of a few stocks from the portfolio collapse, gains in other stocks may simply not be able to compensate for the losses. That leaves the NAV of the portfolio in the negative and hence erosion of capital for investors.

It's also important to time the market and examine the portfolio

While, many analyst advocate not to time the market, the real mantra for success through mutual fund schemes is to time the market. For example, the Sensex is currently a few 100 points away from a new record high. If you buy a mutual fund scheme now, the NAV would be higher, since stock values in the portfolio would be higher. Why would you want to buy a scheme when the NAV is at the highest level?

A better proposition would be to invest in a debt mutual scheme and when the market falls to switch to an equity scheme, since you would get the scheme at a lower NAV.

There is no mantra for generating solid returns through mutual funds. The real story is that it is a game of chance. If the fund manager sees a good stock he buys a solid chunk of it. But than he suddenly realises that the pharma stock he bought faces a US FDA ban or the banking stock he bought is simply not moving because the RBI is just not cutting interest rates. Or, the telecom stock he bought faces regulatory hurdles and the stock price is going nowhere. That's why the returns sometimes remains poor from a mutual fund scheme and your capital remains stuck.

Don't listen to advisors, who keep selling schemes, showing superior returns from some other schemes. Always remember that past track record is no indication of future performance and there are many schemes that are not generating returns as good as bank fixed deposits.

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