#BQMutualFundShow: Why Mutual Funds Cannot Assure Fixed Returns
Assured returns, as an asset class, is probably a relic of past.
The assured return scheme, as an asset class, is probably a relic of past, said Akshay Gupta and Sumit Bhatnagar of Indiabulls Asset Management Company on BloombergQuint’s weekly series, The Mutual Fund Show.
For equity mutual funds, a correction could throw all expectations of a fixed of guaranteed return out of the window while for debt funds, risks like interest rate moment risk or liquidity risk or credit risk will put a question mark on assured returns they added.
Here are edited excerpts from the conversation.
Any kind of return, be it one or half a percent, is not necessarily a given at any point of time.
Sumit Bhatnagar: Assured return in this market is definitely a no-go. Both asset classes, whether it is equity or debt, are risky in their own way. In equity, there are huge drawdowns and periods of low return. In a bull market, this kind of philosophy can work. But if a correction happens, which we saw in 2008, these types of philosophies go out of the window. Debt funds have their own unique characteristics. So, they also face risks like interest rate moment risk or liquidity risk or credit risk. All these risks put together put a question mark on assured returns. As an asset class, assured returns are probably a relic of past. It has been restricted now to bank fixed deposits, endowment funds, public provident fund or NSC. But they have their own problems and complexities including lower returns.
People say let’s park money into the markets, there will be some returns at least. While that may be true if we look 12 - 24 months down the line, would you be confident enough to say that remains a given at the current point?
Akshay Gupta: To stretch the point that Sumit mentioned, this one percent thing is happening in balanced funds in the market. It is basically one percent dividend given. And the same day, the net asset value drops by one percent. When you give a dividend out of a dividend option in a mutual fund, that same amount makes the NAV go down by that much percentage. So, if NAV is 10.1 percent and you are giving 1 percent dividend, it will come back to Rs 10. So NAV comes down when you declare a dividend.
What if the markets were not to give returns, and if the NAV were not to go up, then the overall investment value of investor will go down, right?
Akshay Gupta: It will come out of your capital. If I have invested Rs 10 and it became Rs 10.1 and I am getting a Re 1 dividend, then it comes down to Rs 10. Tomorrow, if the market corrects by 20 percent, my investment goes down to Rs 8. So, even if I keep getting that one percent, I have lost 20 percent, plus I am losing one percent every time I get a dividend. It’s more of a packaging thing because dividend is tax-free in mutual funds. So, people package this as an assured return or guaranteed return product. But the party is on, till the markets are on. The party gets over the moment the markets are down.
If you are attuned to investing in fixed deposits earning 3- 4 percent, and if you are an investor for over 3-5 years, then mutual funds might give you great options as well.
Akshay Gupta: We did a historical analysis on this, and we found out that for time periods varying from 3-15 years, if you did an SIP you would earn 13-15 percent on the index. And 90 percent of funds actually outperformed the index. While there are no guaranteed returns, if you do a longish-term regular investments which take advantage of rising and falling markets then chances are you will make higher returns than fixed deposits and they are more tax efficient because equity as an asset class is more tax efficient if you stay for a long tenure.
The other thing is to remind investors of the risks that are associated with investing in mutual funds. Would you elaborate?
Sumit Bhatnagar: Mutual funds also bear market risks. If the equity market goes down, a mutual fund manager through his skill can reduce the fall but cannot ensure that funds do not fall at all. A fund manager through his sector call, economic analysis or stock picking can mitigate the risk, but can’t eliminate the risk per se.
Likewise, in the case of debt funds, we see a similar situation. Through credit and economic analysis on the direction of interest rates, you can mitigate the risk by proper portfolio diversification and construction. However, if an event like 2013 happens, where then RBI Governor Subbarao increased the interest rate by 300 basis points, the entire yield curve moved up. So, that would be a risk.
Goldman Sachs forecasts three rate hikes in the calendar year 2018 by the RBI. Does that put an end to the interest rate cut cycle that we were in and add a little bit of risk into debt or bond funds?
Sumit Bhatnagar: We believe that the rate cut cycle may be at its end, but rate hikes are probably too far off to visualise right now. Maybe Goldman, in its inflation model has forecast certain things, but we think there is no evidence to suggest that India is on a rate hike cycle. Having said that, if that situation plays out, then duration funds would get hit. The funds that play on 5-10-20-year papers are going to get mark-to-market losses on their portfolios. But shorter duration funds should do fine.
Watch the full interview here.