Last week, on the ETNow Personal Finance show where I answer questions from investors, a particular query made me realise that the Indian mutual fund investor is missing a most important type of fund.
Here’s the question from the viewer, “I am a working woman. I have accumulated Rs 20 lakh in my mutual funds through SIPs over the last 6 years. I also have savings of Rs 7 lakh invested at 8.25 per cent. I may need this money in 5 years. Should I revise my portfolio?” The portfolio itself consisted mostly of excellent equity funds so there was no need to revise it.
However, the five year target for redeeming, the normal advise that I would in order to prepare for the redemption. I advised her that here after, fresh investments should go not to equity funds but into balanced funds. Also, she should start a Systematic Transfer Plan timed to shift her older investments out of equity funds and into a balanced fund. This would ensure that if there was any market volatility at the eleventh hour, then the accumulated returns of the equity funds wouldn’t be affected so drastically.
This kind of exit strategy is based on the fundamental idea that equity investments are only for the long-term. In the short-term, equity has high risk because the value of your investment can rise and fall dramatically. However, when I say long-term, I mean residual long-term. Suppose you have invested in an equity fund for ten years and now you plan to redeem it in two months to utilise it. In this case, this is not a long-term ten-year investment, but a very short-term two month investment. Tomorrow morning, the equity markets could enter a severe bear market and a good part of your money could disappear by the time you need it.
The recommended course of action is what my advice was to the viewer above. In anticipation of using the assets in a long-term investment, start shifting it into fixed-income assets a year or two in advance.
However, even as I gave the advice, I realised there was a flaw, not in the advice itself but in the assumption that this was easy or convenient to understand and implement. A handful of investment geeks might do something like this--or even enjoy doing it--but for the vast majority of casual investors it would be just too complicated. And yet, if one wants that equity fund investors to actually fulfill their financial goals while enjoying the high returns of equity-based investments, then this sort of an exit strategy is an essential part of risk management.
The solution is simple. There should be equity funds that should implement this exit strategy. These should be closed-end funds that should be designed for long-term investments that end on a particular date. AMCs should launch a range of funds, each targeted to end in a particular year. They would ideally be fund-of-funds that just package other funds and implement the exit. The viewer above would just have invested in a 2018 Target fund and the rest would have been done by the fund itself.
The interesting thing is that such funds actually exist in some countries. In the USA, some fund companies launch target date funds for each year going into the far future. Such funds would be ideal retirement or pension funds. Retiring in 2028? Just choose a good fund company and keep investing in its 2028 fund. Or, in order to diversify, split it across two separate 2028 funds. Such a fund would stay pure equity till about 2022 or 23 and then gradually shift to fixed income.
The strange thing is that despite having a huge variety of funds--many of them useless variations on the same theme--no fund company in India has launched a simple, easy to understand, and genuinely useful product as a target date fund.
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