Why Returns From Equity Mutual Funds Maybe Overhyped?

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    It was interesting to read an article stating that one-in-three SIPs, over the last one year have generated losses for investors. 

    We are increasingly seeing novices and beginners to investments making inquiries on mutual funds. Following demonetization equity mutual funds have become an increasingly preferred route for investment, especially for new investors.

    In fact, even brokers maybe selling equity MF schemes without informing investors on market related risks. On a closer examination, we realize that we need to explore some facts and the instrument maybe a little overhyped.

    Examining the performance of some big schemes

    Examining the performance of some big schemes

    Since we often say that equity mutual funds tend to deliver returns in the long term and they meet the long term objectives, let us examine the long term returns of some of the largest equity schemes.

    HDFC Equity, which is among the largest, if not the largest and has assets under management of Rs 21,000 crores, has given a return of 11.48 per cent in the last 1 year, 8.28 per cent in the last 3 years, 17 per cent in the last 5 years and 14 per cent in the last 10 years.

    Now, had you to place money in the bank, 10 years ago, where the interest was around 9.5 per cent, your yield with compounding would have crossed 14 per cent. The three year returns from the fund would not have been better than bank deposits and only the 5 year returns is decent.

    Similarly, another big fund, ICICI Prudential Value Discovery Fund, has given a 1 year returns of 7.15 per cent, three year returns of 6 per cent and 10 year returns of 18 per cent.

    Most of the fund we analyzed is a similar story where the returns have either been bad in the short term or the long term. So, if the feeling right now is that you are going to get phenomenal returns, the answer is to tone down expectations. Here is why...

    Fresh taxes from April 1, 2018

    Fresh taxes from April 1, 2018

    It is going to be even more difficult to get superlative returns from equity mutual funds now. There is a long term capital gains tax that would be applicable on equity mutual funds from April 1, 2018. Apart from this, there is a dividend distribution tax that would be applicable from the same date.

    This means those who are looking at growth options would be hit by the Long Term Capital Gains Tax (LTCG) and those looking at the dividend option would be hit as equity mutual funds would now have to pay a dividend tax of 10 per cent on dividend distributed.

    So, it is a double whammy of sorts. Equity mutual funds and equity shares were the only asset class that were not subjected to LTCG and now they are, just like gold and real estate.

    The mantra is buy

    The mantra is buy "low" and sell "high" remains

    Equity Mutual Funds return are linked to markets and there is no denying the fact that you cannot defy the mantra of buying "low" and selling "high" as the only way to make profits.

    SIPs to an extent can hedge risk, but, here again if you have invested in SIPs in the last 1 year, you have been buying at higher prices for the last 12 months.

    On the other hand, if you are investing lumpsum in equity mutual funds and you are buying when the markets are high, you are likely to be buying at a higher net asset value. There is no way you are going to make money. Of course, you cannot time the markets, but, we all know that the Indian stock markets are expensive at 23 times trailing p/e on the Sensex. 

    This is as against a historical 17 times. 

    So, how do we make money in equity mutual funds?

    So, how do we make money in equity mutual funds?

    If you are investing in equity mutual funds, the only way to make money is to buy high and sell low. This means, buy into an equity mutual fund, when the stock markets are low, as you would get the NAV at a lower price.

    The indices have fallen almost 10 per cent, with the Sensex now at 33,150 points as compared to 36,300 a month ago.

    Wait for a further decline of say about 5 per cent in the markets, just in case you want to nibble into equity mutual funds. Buying "low" and selling "high" is the only way you will make money in equity MFs.

    Check recent dividends of mutual funds here

    Read more about: mutual funds
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