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Complicating the Simple

Investors are missing the basic point of fund investing by falling for speciality funds, writes Dhirendra Kumar

It's a well-established cliché that we should learn from our failures. I say well-established because it has more than an element of truth in it. In mutual fund investing, the situation is even better—so much information is easily available that it's pretty easy to learn from others' failures as well. At this time, when almost all equity funds have made severe losses during the last year, there are more lessons to learn than there were in good times when most funds had a good track record.

Traditionally, one divides mutual funds into core funds and supporting funds. Core funds are those that should form the backbone of any equity-leaning mutual fund portfolio. There can be variations, but basically core funds should be conservatively run funds that invest most of their money in large-cap companies, but could invest in any sector or industry as the market conditions justify. Depending on the investor an equity-oriented balanced fund could also be a core fund.

Beyond core funds, there are the specialty funds. These are funds that have some twist in their tail. They have some limitation on where they can invest. These could be limitations of company size, as with small-cap or mid-cap funds or of industry something else. The basic idea is that the fund manager is not free to invest in any company that he or she wants to. There are some limitations imposed by the mandate that the fund has. It should be clear to any thinking investor that there is no great need for funds which come with strings attached.

Not surprisingly, such funds are given to swinging between extremes of performance. When the market was rising, they were rising more than vanilla funds. But when the collapse started, they fell more than them. Unfortunately, over the last few years, these limited-mandate funds have come to dominate the menu that is on offer from the Indian mutual fund industry.

The whole idea of investing in mutual funds is to get a decent return on one's investment without having to go through the complexity of investment management oneself. You, the investor, just writes 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—it's 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.

When you invest in a generic fund, 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. This move to limited-mandate funds has happened because it has been more convenient, easy and profitable for fund companies to sell new funds with supposedly beneficial features. It saves them from investors asking uncomfortable questions about the performance of existing funds. This is the same kind of features-centric product design and marketing that drives cars, phones or electronics. As long as a new product can come with features that can distract potential buyers, they won't bother about meaningful product attributes.