Mutual Fund Myths Explained In Detail

13.1 Lower NAV is cheaper

The most common myth that is prevalent among mutual fund investors is that of associating a scheme with a lower NAV being a better buy compared to a scheme with a higher NAV. This stems from the mind set of equating mutual fund units with equity shares of a company. NAV of a scheme is irrelevant and irrespective of whether we are investing into a fund having a low NAV or a fund with a higher NAV, the amount of investment remains the same.

Let’s look at a hypothetical investment into two schemes A and B. Scheme A has a NAV of Rs 10 whereas scheme B has a NAV of Rs 200. If we make equal amount of investment of Rs. 1 lakh each in both the schemes. Scheme A would come across as a cheaper buy because we got 10,000 units as against 500 units in scheme B. Now, let us assume that both the scheme returns 10 % in a month. The NAV for scheme A is Rs 11 and Scheme B has a NAV of Rs 220. The value of your investment in both the case is Rs 1,10,000. Therefore, we see that the NAV of a scheme is irrelevant, as far as generating returns is concerned. The only difference being in case of the former, the investor gets more units and in the latter, he gets lesser units. For two schemes with identical portfolio and other things remaining constant, the difference in NAV will hardly matter and both the schemes will grow at the same rate.

13.2. Regular dividends means good performance

Another popular myth which emerges due to the linkages we make between the concepts of a stock markets and mutual funds is the dividend payout mechanism.

When a company pays dividend, in effect it is transferring acerta in portion of its surplus to its shareholders. Therefore a generous dividend payout policy could be considered favourable in case of a company. However, in case of mutual funds, dividends are declared out of the distributable surplus which is included in calculation of net asset value. In effect it is paying back a certain portion of net assets from our own investments. Therefore, dividends from mutual fund units don’t make us any richer, as there are no additional gains to be made. The NAV of the scheme falls to the extent of the dividend payout, when a scheme pays dividend. Thus, a scheme with a high dividend payout record does not necessarily mean that it is performing well. Dividend option may prove important to plan cash flows, especially in the case of tax savings scheme which have a lock-in period and also for tax incidence

13.3. Past Performers are Best to Buy

Despite the disclaimers, mutual fund investors tend to invest in the top performing scheme of the last year, hoping that past performance will ensure that the scheme continues to stay at the top. Therefore, instead of chasing the top performer in the short term, it is advisable to invest in a scheme which features in the top quartile consistently over a longer period of time. In addition to past performance, the investors should also consider other factors viz. professional management, service standards etc.

13.4. Fees and Expenses

As is the case with any other business, running a mutual fund business also involves costs. The various costs incurred by a mutual fund could be associated with transactions made by investors, operating costs, marketing and distribution expenses etc. Expenses borne by the mutual fund investor can be broadly classified into two categories: –

• The load which may be charged to the investor at the time of redemption
• The recurring expenses which are charged to the fund

13.5. Loads or Sales Charges

Loads are charges which investors incur when they redeem units in a mutual fund scheme. A load charged at the time of redemption is known as ‘Exit Load or Back End Load’. Asset management companies charge these loads to defray the selling and distribution expenses including commission paid to the agents/distributors.

Since August 1, 2009 entry load has been banned and therefore purchase/subscription of mutual funds happen at a price which is equal to the NAV. However, an investor is required to pay an exit load (if any) if he chooses to redeem units. This happens at a price linked to the NAV. This re-purchase price price may differ from NAV to the extent of exit load charged, if any. Further, expenses related to New Fund Offer (NFO) are borne by the AMC / Trustee / Sponsor.

13.6. Recurring Expenses

These are costs incurred for day to day operation of a scheme. These expenses inter alia include investment management and advisory fees, trustee fees, registrar’s fees, custodian’s fees, Audit fees, marketing and selling expenses including agents’ commission etc.

Expenses exceeding the specified limit are to borne by the AMC. The recurring expenses (including investment management fees) that can be charged to the scheme are subject to following limits (as a percentage of daily net assets):-

In addition to TER within the limits specified under regulation 52 (6) of the Regulations (as specified above), the AMC may charge expenses not exceeding 0.20% of daily net assets of the scheme, towards investment & advisory fees as specified under regulation 52(2) of the Regulations and/or towards recurring expenses as specified under 52(4) of the Regulations.