Mutual Funds are not for ordinary people !!

I was reading an article in The Economic Times (Dated 5th July 06). It talked about why the mutual funds are not suitable for ordinary investments. The author Rajrishi Singhal convincingly talks about the various reasons why the ordinary retail investers do not get enough service for the money they put into a mutual fund. I do not agree whole-heartedly with what the author says, since despite the entry-loads and the AMC charges which a fund applies on a retail investors, he is better off with MFs than direclty investing in stock markets. Any service provider will charge the consumers for the service it provides. It is a matter of demand and supply as to whether they are levying a higher fees. If the demand for MFs is high then they can easily charge higher fees. If we have more competition among MFs for attracting the retail investors, these charges would automatically drop. In India, still a huge percentage of popluation believes in investing in the governemtn backed secure options. Another point which the author makes is the need for research in investing in MF versus the research to be done in investing in stock market. I still feel that researching about MFs involves a lot less number of parameters than stock markets. The author also does not take into account the diversity of portfolio offerred by a MF. For a same amount fo diversity to be acquired while investing directly in stocks would need a lot of expertise and cash. The only point which I could agree here is the influence of a corporate in a mutual fund. Here is the entire article. The copyright belong to respective owners.

Mutual fund a big boys’ game

It’s not wise for the ordinary retail investor to put his money into a mutual fund; he’s probably better off investing directly in the stock market, argues Rajrishi Singhal

THIS definitely is the season for all kinds of heresies, and it’s time to add a home-grown doctrine of sacrilege. So, here goes: it’s not wise for the ordinary, retail investor to put his money into a mutual fund; he’s probably better off investing directly in the stock market! Sure, this doesn’t quite square with popular belief and common sense, which exhorts retail investors — largely, salaried and middle class people, lumped by market messiahs into this one-size-fits-all category — not to invest in stock markets but restrict themselves to mutual funds. But, it’s actually one big myth perpetrated to suck out cash from unsuspecting wallets. Here’s why. Most mutual funds remain intrinsically an instrument for large corporates to park their short-term surpluses, and only provide lip service to retail investors. The industry structure too has evolved to only accommodate bulk investors — largely cash-rich corporates — rather than to improve the ordinary individual investor’s savings and investment profile. Here are four key reasons why mutual funds have ended up being antithetical to the interests of genuinely retail investors. Reason 1: The vile villain in this topsyturvy scheme is an innocuous levy called “load factor”! This is the fulcrum around which all mutual funds have spun their web of inequity. This levy essentially charges all investors who invest below a certain threshold amount an “entry load”. For example, many funds charge all investors investing below Rs 5 crore an entry load of 2.25%. Assume you have invested Rs 10,000 in a particular mutual fund, in units of Rs 10 each. But, instead of costing Rs 10 each, the units will now cost you Rs 10.225 each. So, while you should have been allotted 1,000 units, you are now been allotted only 977 units! Therefore, the fund — which was set up with the mandate to make you richer — has made you poorer even before they invested a single rupee in the market. Talk of trusting your money to a complete stranger! Reason 2: The pillage does not end there. Most managements thereafter bill the fund a “management fee” and sundry other charges to take care of all the expenses incurred by the AMC management as well as to ensure that it has a margin at year-end to keep the AMC shareholders pleased. No issues about that, since no one expects the AMC to manage a pool of money for a bunch of anonymous investors without earning a fee. The discrimination lies elsewhere. The fee is levied on the total assets under management (which is the pool of invested money), and is shared alike by both bulk as well as retail investors. But for the wholesale investor, this is the only levy. For the retail sucker, this is a double whammy, in addition to the entry load. The exploitation of the poor retail investor does not stop here. The fund might end up losing wealth for the investor (as indeed many have in the past). In such an event, the investor has to exit with a sum lower than his original investment. Guess what? There is no change in what the AMC earns, whether the fund does well or disappears down the tube. The AMC’s earnings are performance-proof. What actually counts is the size of the fund, since the fee is usually a percentage of the assets under management. Therefore, the larger the fund size, the larger is the fee in absolute terms. THIS is the root of the cancer, called “entry load”. In their pursuit to ramp up assets under management, most fund managements spend aggressively on sales, marketing and distribution. In fact, most funds have tied up with third party distribution companies, which levy a huge fee that is higher than the 2.25% entry load and eats into the AMC’s fees and the other permissible expense charges. Most fund managers estimate that after meeting the distributor’s commission and recurring expenses (such as, printing, fees to registrar and transfer agents, property rentals, various administrative expenses and salaries), they are left with 0.70-0.75%, which is lower than that allowed by law. Therefore, what matters here is the size of the kitty and hence the race to ramp up assets; no wonder mutual funds are not only fawning all over the distribution guys but are loath to do away with “entry load”. Reason 3: It is an accepted fact that cor porates have an overwhelming presence in most funds. With such a sway over funds’ fortunes, most corporate actions do cause grief to retail investors. Here’s how. When one corporate decides to redeem its units in a mutual fund, the AMC is able to take it in its stride and not much harm is caused. But, usually, most corporates decide to move out of a fund herdlike, which then has fund managers scrambling around to sell investments to raise cash to meet redemption obligations. When that happens, it automatically harms the asset value of the fund. Guess who’s left holding the can? Reason 4: This one’s not about finding faults, but just an observation. Most retail investors are advised not to invest in shares since, as they are often admonished, they have neither the expertise to pick stocks nor the time to research individual companies. But, the same problem of multitude exists even in the mutual fund landscape. There are over 700-800 schemes today, with many offering multiple choices, leading to over 1,200 net assets values being published daily. So, if you want to invest in a fund today, you would need to research over 700 schemes. Does this not require skill, expertise, time, etc? A solution could be to make rating compulsory for all mutual funds, and to publish these ratings periodically. The cancer in the mutual fund industry has eaten so deep into the system that even regulators find certain doubtful practices as acceptable. In fact, this absurd cost structure, which corrodes a retail investor’s wealth, even has the sanction of law. In the past couple of years, thanks to some vigilant media pressure, the regulators have certainly pulled the plug on some corrupt practices and imprudent accounting methods that were directly benefiting corporates and fleecing the retail investors. But the regulators need to do much more before retail investors feel really comfortable with mutual funds and stop burning their fingers in the stock market. Till then, blasphemy will continue as the ruling faith.

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