Attracting first-time mutual fund investors

By Ravi Samalad |  18-03-20 | 

It is well documented that investors tend to chase products delivering highest returns, often ignoring their own risk appetite. To make quick bucks, many investors dabble into stocks and derivatives based on tips from friends and media. And once they have a bad experience with markets, they tend to grow averse to volatility.

The investor education blitzkrieg unleashed by the industry is drawing people’s attention towards mutual funds. Awareness is one thing and actually investing in line with one’s goals is another.  For beginners, the overwhelming choice of funds also makes investing in mutual funds a hard task.

This makes the job of an adviser even more critical who has to bust the per-conceived notions or assumptions/questions like (how much returns can I expect? Why is my fund delivering negative return,? Should I pause my SIP because market is falling?) which prospects might have while investing in mutual funds for the first time.

Just like a beginner can’t run a long-distance marathon without adequate practice, novice investors would do well to avoid the pitfalls of investing directly or investing in funds by merely looking at their past returns. Investors need to learn about different products, the risk-return trade off and how they fit into their goals.

Setting right expectations

The first step in any client onboarding process is setting right expectations and educating investors. “We develop plausible scenarios and discuss the implications which does away with myopic behavioural biases. This also helps us retain them at a time when the markets are tizzy because having made them understand the basics of finance and investing (like rupee cost averaging in SIPs), our clientele is better equipped to handle what we  usually witness - miscalculated behavioural issues (the omnipresent fear and greed factor) like investing at high P/E and market levels and exiting at low. So chances of retention are higher. We also make sure it is a collaborative role that clients play in decision making,” says Shifali Satsangee of Funds Ve'daa.

For clients looking to deploy a high-ticket lumpsum in mutual funds, Shifali makes them invest the corpus into a liquid fund with a dividend transfer plan into a diversified equity or dynamic asset allocation fund. This ensures safety of capital, exposing only the dividend component to volatility.

Suresh Sadagopan of Ladder7 Financial Advisories suggests that advisers should first ascertain why prospects are approaching them. “Advisers should find out whether the prospect is already working with some other adviser. Why is he coming to you? It might happen that the prospect is approaching you to earn higher returns because his existing portfolio is not meeting his/her expectations. For this, advisers need to deep dive and ask a lot of questions. This gives us an idea about their current situation, why are they leaving their current adviser and coming to you, their goals, and expectations.”

 Avalanche of choice

Post recategorization, fixed income funds now have 16 categories which can overwhelm any client. Also, not all debt funds are suitable for risk averse investors. So conducting a risk profiling is a must.

Let’s take a brief look at a few fund categories suited for risk averse first-time investors:

Overnight Funds

These funds invest in securities which mature in one day which makes them the safest and highly liquid investment avenue among all categories of debt funds. Since the investment horizon of these funds is only for a day, they are immune to interest rate changes. After SEBI imposed exit loads in liquid funds, the overnight category is attracting investor attention. These funds deliver lower returns in comparison to liquid funds. Over a one-year period the difference between the return of an overnight and liquid is around 74 basis point.  Clients with an investment horizon of up to one month can invest in this category. These funds do not levy exit load.

Liquid Funds

Liquid funds invest in debt and money market securities like certificate of deposits, treasury bills, government securities, commercial papers with maturity of up to 91 days. Some funds provide instant redemption facility up to Rs 50,000 24X7 which helps investors get their money in their bank accounts in a few seconds.

While liquid funds are reasonably safe, it is worth mentioning that these funds yielded negative returns on rare events like in response to the impact of Fed tapering announcement in 2013. In the race to earn higher returns, some liquid funds have been investing in risky bonds which impacted the returns in a few schemes. But these instances are a few and far between. Post the new valuation norms introduced by SEBI, liquid fund returns are now marked to market and reflect the actual worth of the portfolio on any given day. This gives a clear picture of the actual returns earned by investors. Over one-year, liquid funds have delivered an average of 6 % return. Liquid and overnight funds are no longer allowed to invest in debt securities having structured obligations and credit enhancements which has further reduced the risk.

Liquid funds have started levying a graded exit load which becomes nil from the seventh day. The investment horizon should be at least seven days for any client to avoid exit load.

Both liquid and overnight funds can be used by clients to park their surplus cash.

Banking & PSU Funds

Banking & PSU funds have been gaining investor attention lately due to a flight to safety. Safety has become a prime concern for investors, especially in the aftermath of the markdowns witnessed owing to downgrades and defaults following the outbreak of the NBFC crisis in September 2018. Thus, this category received flows worth Rs 16,856 crore in the quarter ended December 2019 up by 57% over the previous quarter. The total assets of this category have now grown to Rs 70,925 crore up by 35% over the last quarter.  As a result, total assets of the Banking and PSU category have now overtaken the Credit Risk category.

Investors willing to take moderate volatility can consider banking and PSU funds, which predominantly invest in AAA rated paper. They are mandated to invest a minimum 80% of their assets in debt instruments of banks, public sector undertakings, public financial institutions and municipal bonds, which are safer from credit perspective.  Advisers can recommend these funds by looking at the actual portfolios. Preferably, portfolios with a tilt to AAA rated paper would be ideal for conservative investors.

Pitching debt funds

Some first-time MF investors could question the rationale for investing in products like mutual funds, which don’t assure returns. Leaving the credit risk and duration risk aside, which are inherent in debt funds, some fixed income funds can generate a favourable post tax return vis-à-vis fixed deposits offered by banks. Debt funds enjoy indexation benefit if one invests for more than three years. This essentially reduces the tax outgo, thereby increasing post tax returns.

Assume a client (with tax bracket of 30%) has invested Rs 5 lakh in a debt in 2014. At the end of three years, the fund has accumulated value of Rs 6,12,521, yield 7% return. The FD investor earns a post-tax return of around 5%.

A debt fund investor pays only Rs 6,071 at the end of third year. This is because the cost of acquisition has gone up after accounting for inflation. The Cost of Inflation numbers are published by the Income Tax Department.  CII index was 240 in 2014 and went up to 280 in 2018.

Here’s how the cost of indexed acquisition is calculated. (5,00,000 X 280/240 = Rs 5,83,333). The pre-tax gain for debt fund investor is Rs 1,12,521 (6,12,521 – 5,00,000). But after accounting for indexation, the debt fund investor has to pay tax on only Rs 29,188 (6,12,521 - 5,83,333), which works out to Rs 6,071. Thus, a debt fund investor earns higher post tax return 6.65% as compared to FD investor (4.82%).

It is pertinent to note that investors falling in tax bracket of 10% do not gain much by availing indexation benefit from debt funds beyond three years.

Further, debt funds provide easy liquidity as compared to bank FDs where premature withdrawals are penalised. Mutual fund portfolios by their very nature are diversified which reduces the risk in comparison to investing in a single product.

Summing up

Both debt and equity are essential ingredients of a sound portfolio. A well-designed portfolio that plies the principles of asset allocation can help investors achieve their investment goals.

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