MF – Distinguish between genuine and fancy

The mutual fund industry is a classic example of Herd mentality. Most fund houses tend to crank out similar schemes one after another, whether it’s technology funds, or thematic funds that focus in opportunity, multi-cap, close ended, fixed maturity, arbitrage, capital guaranteed and so on. And now, investors can look forward to real estate mutual funds.

Innovation is certainly good and healthy for the growth of the Indian mutual fund industry, which is still in its infancy, compared to its American counterpart. Contrast our US$ 120-billion (Rs 5 lakh crore) industry with US mutual fund industry, which has some $10 trillion under management. Fidelity, Vanguard and American Funds manage $ 1 trillion each. This shows that the Indian industry is really quite minuscule, since the assets under management (AUM) here are around 1% of those in US mutual funds.

It also shows that there is a lot of potential for the industry to grow over a period of time. One statistic is often come across is that around 52% of the US population is invested in mutual fund products as against the 4.5% (in equity) that we have here lately (up from 1.2% earlier). Retirement plans in the US rely predominantly on mutual funds. Compare this with the options for growing one’s retirement corpus that are available to Indians through their employers the Employees’ Provident Fund guarantees 8.5% interest which changes from year to year, based on political compulsions, prevailing interests rates, and so on. All this is set to change with the launch of pension products in the country. Additionally with asset management companies such as Goldman Sachs, UBS and Aegon planning to start operations, choices are bound to increase, Sounds good, but it will also add to the confusion of investors.

Despite all the changes and competition, what is lacking in the industry is the nerve to do what’s in the best interests of the investor. In the race to garner more assets and reach the coveted top position, mutual fund houses look for distributors who can sell more (never mind how the sales are done). Lavish parties and vacations are among the incentives given to sell more. The barriers to entry being low, every little is paid to the quality and education of advisors.

The financial service industry deals in the manufacture and distribution of finance products as analogous to a doctor – someone who diagnoses a problem, prescribe a solution, and ensures future good health ad a distributor of financial products as analogous to a chemist. In the financial service industry difference between a ‘doctor’ and ‘chemist’ is blurred.

Distribution and advice are two separate things, and this is better understood by the mutual funds themselves. Awards are often given on the basis of assets under management to outfits that are sometimes pure distribution houses. Although a chemist’s may have multiple locations and crores worth of sales, it can never win the award of being the best doctor. But financial advisors are rewarded on the basis of how much they sell, never mind the churning and mis-selling. And, of course, if things go wrong, the buck can always be passed on to the agent, who is the point of contact with the investor.

So how an average investor protects his or her interests? Firstly ignore the fancy advertisements and illustrations that are likely to show tall promises but may not actually deliver anything close. Sure, structured products sounds impressively complex, but don’t put money down until you’ve understood what it means, and don’t take anything at face value. Secondly, you and your advisor should take a holistic view of your situation. And opt for products that will fit overall framework of your asset allocation. This can only be done when you take into account not only your investment returns, but also your liabilities, liquidity needs, risk management needs, risk behavior, overall current situation, and time horizon. An investing decision must make sense in its specific context.

And thirdly, keep in mind that wishful thinking is often quite a different thing from reality. It’s not all uncommon for investors to come across promises of returns of 30% or more from equity, promises of doubling your money swapping real estate, of fancy returns from ULIPs. The ability to distinguish nonsense from genuine good advice will not only keep investors’ financially fit, but enhance their wealth.

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