A HDFC Bank Ltd. teller counts Indian 100 rupee banknotes at a branch in Mumbai. Photographer: Dhiraj Singh/Bloomberg

The Mutual Fund Show: Demystifying The Jargon Financial Advisers Use

Indexation, CAGR, alpha… confused about these mutual fund terms? You’re not alone. Newbie investors often get confused by the jargon financial professionals use.

A common doubt is about “entry and exit loads”. Exit load is a fee that mutual funds charge investors for exiting or leaving a scheme, Vijai Mantri, chief investment strategist and founder-promoter of JRL Capital, said on BloombergQuint’s weekly series The Mutual Fund Show . “If the fund house has 1 percent exit load, then out of the total redemption proceeds, 1 percent will get deducted.”

Watch the full conversation with Vijai Mantri in which he demystifies financial terms:

Edited excerpts from the conversation:

What is alpha?

Vijai Mantri: Alpha is the value the fund manager is adding when you invest in a fund. For instance, if Nifty delivers 10 percent return and the fund manager is able to deliver 10 percent-plus returns, then the plus return is alpha. So, return in excess of underlying benchmark is called alpha.

What is beta?

Vijai Mantri: If your beta is more than 1 percent, then it’s high and if it’s less than 1 percent, then your beta is low. Market has a beta of 1 percent. If a fund or strategy has beta 1.2, it means that if the market goes up by 1 percent, that fund will go up by 1.2 percent. If the market goes down by 1 percent, that fund will go down by 1.2 percent. This means that the fund is 20 percent riskier or aggressive than the market. If the market falls, the high beta will fall even more and if the market goes up, the high beta goes up more.

What is entry load and how does the math work?

Vijai Mantri: If you have an entry load of 2 percent, it means that when you invest Rs 1 lakh, then Rs 2,000 gets deducted and only Rs 98,000 gets invested in portfolio management services or alternative investment funds scheme. PMS needs Rs 25 lakh of minimum investment whereas AIF requires a minimum investment of Rs 1 crore. So, if you invest in PMF of Rs 25 lakh and it says entry load of 2 percent, it means Rs 50,000 gets deducted and only Rs 24,50,000 gets invested.

What is exit load?

Vijai Mantri: For liquid schemes, there is no exit load. When you move up the curve from liquid to ultra-short, low, medium-duration fund up to equity, then increasingly there is load put in. If someone says, exit load of 3 months; it means, you exit money before 3 months after investing in scheme. Suppose the fund house has 1 percent exit load, then out of the total redemption proceeds, 1 percent will get deducted.

What is risk grade?

Vijai Mantri: There is a graph where on one end it’s lower risk product, and on extreme end it’s high risk product. So, lower risk side has liquid fund where average maturity of portfolio is around 60 days. So, it’s low risk strategy in which negative returns are rare for a one-day period. Then you go to ultra-short duration fund where the maturity is a little higher. For credit fund, there is credit risk. So, risk keeps on increasing. If you go to balanced fund which has mix of debt and equity, it is in the middle path where debt provides stability, but equity is a risky asset category. When you move to large cap, there is more risk. In mid and small cap, it becomes much more riskier as they are volatile. So, it depends on profile of fund. Beyond the risk factor, one has to look at the time horizon. If the time horizon is 10 years, then liquid is not the safest product.

What is turnover ratio? Should we grade funds on basis of turnover ratio?

Vijai Mantri: Turnover ratio means a sum of purchases made by the fund house on buying equities and selling of equities. So, it’s “buy” and “sell” put together as a percentage of total asset of the fund. If a fund is continuously getting inflows, then it will have high turnover. If the fund is facing redemption, then also there will be a high turnover.

What is rupee cost averaging?

Vijai Mantri: Under the rupee cost averaging, you buy more when prices are depressed and buy less when prices are up.

What is indexation and how would investor get the benefit of indexation?

Vijai Mantri: Indexation is not applicable to equity mutual fund, portfolio management schemes. It is applicable in other assets like immovable property and unlisted shares with a window of two years. You have indexation after you invest for at least two years. For rest of the assets, it is 3 years. If you look at debt and jewellery, it is beyond three years.

Suppose you bought something in the current financial year. Let’s say you invested in a debt mutual fund and in three years the value of Rs 1 lakh has become Rs 1,30,000. So, Rs 30,000 is your gain. Ideally, you should be paying tax on Rs 30,000. But we have a concept called indexation. The indexation numbers which is Cost of Inflation Index comes every year from income tax department. Whatever is the consumer inflation of the last financial year, 75 percent from it is taken as a CII. Indexation increases the cost of asset but there has to be time period. You can’t use indexation in debt fund before three years.