In MFs Vanilla is the Best Flavour

I've always thought that investing in mutual funds was about getting a decent return on one's investment without having to go through the complexity of investment management oneself. You write a cheque and that's that. After that, which sector or industry is doing well or badly and what to move in or out of is no longer your headache. All that is the fund manager's problem. In fact, this offloading of decisions to a professional fund manager is the whole point of investing in a mutual fund. However, when I look at the kind of funds that are being offered to the public and the kind that the public is buying, I see a very different picture.

During November and December so far, 11 new equity mutual funds have been offered to the public. Out of these one-exactly one-is of the type where the fund manager will be taking the entire gamut of investing decisions. In all others, you-the investor-will have to lend him a helping hand. Let me explain. Almost all funds that are launched nowadays are specialised in some way. There are real estate funds, energy funds, small companies funds, emerging marketing funds, and so on and so forth. Per se, there's nothing wrong with the idea of specialised funds. I'm sure many of these will be well-run and provide great returns to their investors. There's no harm in a small percentage of one's investments in specialised funds.

However, when almost the entire market for mutual funds gets converted to specialised funds, then there's a problem, because deciding between these funds is a job by itself. When you invest in a well-run generic equity fund that can invest in any kind of company, then it's the fund manager who decides what type of sector, industry or size of company to invest in. It's his job to analyse trends and figure out how much of your money needs to be in technology or oil companies or infrastructure or real estate or whatever. But when you invest in specialised funds, then that analysis and that decision has to be made by you. You must take a call on what percentage of your investments to put in what industry and when to put it in and when to pull it out and switch to some other industry or type of company. Does this sound like a good deal to you? It doesn't sound like one to me.

By investing in specialised funds investors are losing out on what I believe is the major advantages of investing in mutual funds. And yet if you look at the hype being rolled out by the fund companies' marketing machinery, you'd think that specialised funds were the only things that make sense. And the reason is that for that for the marketing machinery, this strategy does make sense. All marketing people know that unless you differentiate your product from the competitors, you're going to have a hard time selling it. Now there are two ways of differentiating a fund. Either you can differentiate by actual track record of the fund manager, the fund company and the fund. Or you can invent meaningless features and specialisations. Guess which one is easier to do?

I know it's hard to avoid something special and choose a simple alternative. But when it comes to mutual funds, Vanilla really is the best flavour.

(Source: Value Research)

Sundaram BNP Paribas Balanced Fund declares Dividend

Sundaram BNP Paribas Mutual Fund has announced a dividend of Rs. 3 per unit on the face value of Rs. 10 under Sundaram BNP Paribas Balanced Fund.

The record date for the same is December 14, 2007.

Calculating Annualised Returns

In a portfolio, how does one calculate Annualised returns? I would like to know the mathematical formula used, especially in a complex case such as:
1. SIP
2. Partially realized gains
Please try to explain each with an example.
- Kapil Khanna

At Value Research, we use two methods of computing fund returns over a period of time. Returns of fund's performance for a period of less than 1 year are Absolute Returns and that in excess of 1 year are Annualised Returns.

For Annualised returns, we use the CAGR formula i.e. Compound Annualised Growth Rate formula.
If an investment of Rs 5,000, made five years ago has grown to Rs 6,500 today, then the absolute gain would be Rs 1,500 - a 30 per cent growth on initial investment. A 30 per cent return on investment would normally qualify as good but for the fact that it was realized over five years. If you want to know how much the investment has grown on a yearly basis, you will have to take a look at the compounded Annualised growth rate (CAGR).

The CAGR tells you the return a fund turned in every year during the five-year period, provided the gains were re-invested every year. In this case, the CAGR works out to 5.38 per cent. So, in the first year the investment would have grown to Rs 5269. In the second year, it would have been Rs 5552.4 (by adding 5.38 per cent of Rs 5269) and so on. In India, mutual fund regulations require that all returns over one year should be stated in Annualised terms.

On our website, we calculate the returns for less than a year using the absolute method and those above a year as Annualised.

For calculations of SIP returns, the complex formula of XIRR is used. You can access this formula in a software like MS Excel. To calculate you should list your monthly SIPs as an outflow respective to a date and then write the final value on the respective date of calculation. The XIRR formula would give you the internal rate of return of your investment.

Date Cash Flow 01-Jan-06 -1000 01-Feb-06 -1000 01-Mar-06 -1000 01-Apr-06 -1000 01-May-06 -1000 01-Jun-06 -1000 01-Jul-06 -1000 01-Aug-06 -1000 01-Sep-06 -1000 01-Oct-06 -1000 01-Nov-06 -1000 01-Dec-06 -1000 10-Dec-06 13000 XIRR 0.177 Annualised Return 17.70%

In the above table you see a monthly SIP of Rs.1000 which is taken as outflow every month. On December 10, 2007 the value of the investment stands at Rs. 13000. The XIRR function helps you calculate your annualised return i.e 17.7 per cent.

(Source: Value Research)

Birla Sunlife on the Top

On the whole, of the total 467 rated funds, 39 funds have been upgraded and almost as many (43 funds) downgraded. 383 funds have maintained a status quo.

As on October 31, 2007, as many as seven funds gained the 5-star tag: DSPML Balanced, Birla Gilt Plus Liquid, Birla Sun Life Frontline Equity, HSBC MIP Saving, Grindlays GSF PF Regular, Templeton Floating Rate ST Inst and LICMF Floater MIP Plan A. The first six of these funds have been upgraded from 4-star rated to 5-star rated funds. LICMF Floater MIP Plan A, after fluctuating between 3 and 4 star rating, has moved up two steps to become a 5-star fund thanks to its improved returns. DSPML Balanced made a comeback to the 5-star club after being out of it for four months. Two funds, Tata Dividend Yield and Reliance NRI Equity, have been rated for the first time this month. Being rated for the first time, Reliance NRI Equity has begun its rating life in the elite club of the Value Research Fund Rating with a 5-star tag. Tata Dividend Yield has scored a 3-star tag. As many as ten funds lost their 5-star tag while ICICI Prudential Dynamic slipped to become a 2-star tag after enjoying the 4-star tag for the past six months. As far as the fund families are concerned, Birla Sun Life AMC tops the chart with six of its funds finding a place in the top-rated category and 14 funds with a four-star tag. Closely following it are the ICICI Prudential and SBI Mutual; lagging behind by just one step with five 5-star rated funds. Fund Families: How they Stack Up AMC Name « «« ««« «««« ««««« ABN AMRO 2 2 2 1 - Benchmark 2 - 2 - - Birla Sunlife 3 6 10 14 6 BoB 2 4 3 - - Canara Robeco 2 2 4 5 - DBS Chola 1 3 3 1 1 Deutsche 1 3 2 2 1 DSP ML 2 3 4 4 2 Escorts 1 4 3 - - Fidelity - - - 1 - Franklin Templeton - 7 19 8 2 HDFC 3 7 9 7 4 HSBC 1 1 6 4 1 ICICI Prudential - 5 18 10 5 ING - 6 5 4 - J M 3 6 3 1 - Kotak Mahindra 1 2 10 3 3 LIC 4 3 7 2 2 Principal 1 6 6 5 2 Quantum - - 1 - - Reliance 3 - 6 5 3 Sahara - 1 2 3 - SBI 4 5 8 5 5 Standard Chartered 2 5 4 3 1 Sundaram BNP Paribas 2 5 5 4 1 Tata 1 5 10 10 4 Taurus 3 1 2 - - UTI Mutual Fund 3 11 11 3 4 As on November 30, 2007

(Source: Value Research)

The Ideal Plan

Which plan is ideal for me- growth, dividend payout or reinvestment?
- Anonymous

The treatment of gains and taxes are the two essential features that differentiate these plans. If evaluating the returns from an investment at a point of time, there is no difference among the three options. The difference emerges in an implicit form with respect to the applicable taxes.

Gains: In case of a growth plan, gains made are reflected in the higher NAV of the fund. The capital appreciates and investors can cash in on this by redeeming units. Under this option, the decision of booking profits is that of the investor. In case of dividend plans, the fund manager takes a call and distributes gains amongst investors in the form of dividends. Under the dividend payout option, the dividend is paid to you and the NAV falls by the extent of such a payout. It is up to you to reinvest that money as you deem fit. In case of dividend reinvestment, the dividend is paid out by issuing additional units. Hence the dilemma of reinvesting your dividends is taken care of. The biggest benefit here is that the discretion of booking profits is left to the fund manager.

Taxation of Equity Funds: As far as the growth option is concerned, one needs to pay taxes on capital gains. If the units are sold within a year, a short-term capital gains tax of 10 per cent is levied. There is no tax payable on long-term capital gains which comprise of units held for more than a year.

Dividends are tax free in the hands of the investor. When a fund house distributes dividends, it is required to pay a dividend distribution tax (DDT). There is no DDT applicable on dividends declared by equity and balanced funds.

So if you intend redeeming units within one year of investing in a fund, you would be better off under the dividend option. But such a strategy is not foolproof for investors will be at the mercy of the fund house to distribute dividends. Not to mention the fact that an investment time horizon of less than a year is not advisable for investing in equities.

Taxation of Debt Funds: The treatment of debt funds is slightly complicated. Dividends distributed are liable to DDT which implicitly eats into the corpus that could be potentially in your hands. In case of money market or liquid funds, the DDT (inclusive of surcharge and cess) amounts to as much as 28.33 per cent. For all other type of debt funds, the DDT (inclusive of surcharge and cess) amounts to 14.16 per cent for individuals and Hindu Undivided Families. The tax for all other assessees stands at 22.66 per cent.

In case of debt funds, a short-term capital gains tax depending on your income bracket is levied for units redeemed within a year of investment. Long-term capital gains tax is 10 per cent (plus surcharge) without indexation and 20 per cent with indexation. Therefore, purely in terms of tax efficiency, one ought to stick to the growth option in case of money market and liquid funds.

For all other debt funds, if you are in the middle or higher tax slab paying 20 per cent or more as income tax, then the dividend option will make more sense over the short term. For the long-term debt investor, growth would be the way to go.

Making the right choice: Some people prefer using the dividend payout option as a source of regular income. The glitch with this is that funds are not obligated to declare dividends even under a monthly dividend plan. Moreover, the quantum of the payout will not be consistent. Our advice is not to opt for the dividend option as a monthly source of income. You would be better off instituting a Systematic Withdrawal Plan for this.

The dividend option is suitable for those who would like to book profits regularly and redirect such money to other financial instruments such as a fixed deposit. For all other purposes, the growth option offers more flexibility in decision making.

There is an exception though. In case of ELSS or tax planning funds the dividend payout plan is superior. This is because the dividends paid out are not subject to a three-year lock in. And while you cannot redeem your principal units for three years, under the dividend payout option you can at least avail of the profits made here. However, one should absolutely steer clear of the dividend reinvestment plan under this category because the additional units received are subject to the three year lock in.

(Source: Value Research)