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Mutual funds: What 2007 has in store
Kayezad E. Adajania, Outlook Money
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January 05, 2007

In 2006, equity markets gave good returns, despite a cautionary warning. While the Sensex returned 45.9 per cent, diversified equity funds returned 32.2 per cent on an average.

This might sound like a poor show for mutual funds, but most of them have had a sizeable portion invested in mid-cap scrips that were volatile this year. The Sensex, on the other hand, is composed of only large, blue-chip companies.

If 2004 and 2005 were years of mid-cap-oriented funds, 2006 saw large-cap funds staging a comeback. Diversified equity funds that tilted their portfolios towards mid caps the past two years, sold off their mid-cap holdings and bought many large-cap scrips. So, while these schemes returned 32.2 per cent, mid-cap funds on an average returned 29.6 per cent.

Systematic investment plans doubled in 2006 from 75,000 accounts in December 2005 to around 150,000 accounts in November 2006. Debt funds continued their slump on account of volatile interest rates and returned 4.7 per cent on an average.

Up and Down

The Indian mutual fund industry grew 58 per cent, from Rs 2, 07,979 crore (Rs 2079.79 billion) in January to Rs 3,29,162 crore (Rs 3291.62 billion) in November 2006.

Benchmark Mutual Fund was the largest growing fund house. Its assets under management of Rs 1,267 crore (Rs 12.67 billion) in January, grew 606 per cent to Rs 8,951 crore (Rs 89.51 billion) in November.

Its growth was largely led by Bank BeES - a CNX Bank Index-linked ETF that grew 773 per cent from Rs 852.9 crore (Rs 8.53 billion) in January to Rs 7,446.5 crore (Rs 74.47 billion) in November.

Though much of its inflows came from foreign institutional investors, ETFs, in general, are gaining popularity among the retail investors too. An ETF scores over an index fund on account of lower costs and, hence, a low tracking error.

Sahara and Canbank Mutual Funds were the biggest losers in terms of AUM. While Sahara lost 56 per cent {from Rs 464 crore (Rs 4.64 billion) in January to Rs 203 crore (Rs 2.03 billion) in November}, Canbank dropped 19 per cent {from Rs 2,843 crore (Rs 28.43 billion) in January to Rs 2,305 crore (Rs 23.05 billion) in November}. Poor performance and inability to attract fund management talent were the common evils. 2007 may be tough on such fund houses as competition hots up with new fund houses expected to hit the market.

New schemes and fund houses. Thirty-eight new equity schemes were launched in 2006 and garnered around Rs 27,400 crore (Rs 274 billion). New categories of funds, like capital protection-oriented funds and equity derivative funds, were launched.

And just when we thought we had seen the last of sectoral funds, JM MF launched two sectoral equity schemes targeting the financial services and telecom sectors. The response, though, was weak. The rush for equity initial public offers saw Standard Chartered Mutual Fund launching an equity scheme that aimed to invest in such IPOs to make listing gains.

Three fund houses, OptiMix, Quantum and Lotus Mutual Funds, made a debut in the Indian market. While OptiMix is India's first specialised fund of funds house, Quantum is the country's first fund house to avoid the distributor route to sell its own schemes.

With fund distributors demanding fees as high as five per cent of the initial collection -that eventually goes out of your scheme's net asset value, it was a nice change to see a fund house daring to go it alone.

Quantum Equity Fund, its first offering, garnered mere Rs 11 crore (Rs 110 million), the third lowest collection by any equity fund this year. Only time will tell how far Quantum will succeed in its approach.

Some fanfare and many hiccups later, Lotus Mutual Fund finally launched two schemes - a tax-saving equity fund and a liquid fund. 2007 will be an acid-test year for this fund.

New laws. The Securities and Exchange Board of India's mutual fund guidelines completed 10 years in 2006. After much delay, Sebi also gave a nod to gold ETFs in October. The regulator is also close to issuing guidelines on real estate mutual funds, according to sources.

In April, Sebi banned open-ended mutual funds from charging the six per cent new fund offer expenses and its amortisation. Only closed-end funds were allowed to charge the NFO expenses.

This was a good step as many  'new' schemes that were actually just clones of the existing ones, were launched in order to charge the high NFO expenses, pass more commission to distributors and show higher inflows.

Sebi also empowered mutual fund trustees to certify that an NFO launched by the mutual fund is different from any of its existing ones. The intention was good, but there was a loophole - a closed-end fund is said to have a different characteristic from its open-ended peer even if their scheme objectives are the same.

Mutual funds exploited this and launched 12 closed-end equity funds that garnered Rs 8,400 crore (Rs 84 billion), up from nil in 2004.

Looking ahead

Realistic returns. Exercise caution going forward. Expect returns to be more realistic. Says Amitabh Chakraborty, business head, Brics Securities, "The Sensex will return around 10 to 12 per cent in 2007." Ignore short-term blips if you are in for the long haul. Expect diversified equity funds to outperform index funds in the long run. But if you want to avoid the fund manager's risk, go towards ETFs.

New funds and schemes. A total of 13 new fund houses are either waiting for Sebi's approval or have plans to enter the Indian mutual fund market. Expect more NFOs to hit the market. More capital protection schemes will be launched, as will India's first gold ETF. And, if Sebi issues REMF guidelines, we might just be able to see India's first REMF as well.

Opt for NFOs with care as fund houses and distributors have been known to play the 'Rs 10 NFO' myth. It is safer to invest in schemes that come with a proven track record.

Go SIP. Predicting which route the equity market will take is anybody's guess. Will 2007 see a correction or will the market remain bullish? In face of such volatile conditions, opt for SIPs if you want to invest in equity funds, especially for the long term. In this way your fixed monthly or quarterly investment in an equity fund will buy fewer units if the NAV is high, and more units if the NAV is low.

Try a systematic transfer plan if you have a lump sum to invest; you invest the entire amount in a liquid fund and instruct your fund house to transfer a fixed sum of money at periodic intervals to an equity fund of your choice. This way, your money earns on average of four to five per cent while it lies in the liquid fund (a good one to one and a half per cent more than what your savings bank account would give) and then earns equity-level returns on the sum transferred.

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