Fund managers have limitations, hence, they cannot look at illiquid stocks like, say, Cholamandalam Investment & Finance or EID Parry, but ordinary investors can invest in such shares. Is it better to avoid mutual funds in such a situation?
Sukumaran, via e-mail
Fund managers definitely have limitations in buying illiquid securities. SEBI regulations stipulate that illiquid securities should not form more than 5 per cent of a fund's portfolio. More than that the fund managers avoid illiquid shares, as these stocks are difficult to buy as well as sell. Even if you manage to sell illiquid stocks, there is often a significant impact cost. A lack of liquidity does not allow price discovery. Also from a fund manager's point of view, it is always safe to buy large and well-known scrips, which are highly liquid too. As they say, 'No one ever got fired for owning Hindustan Lever'.
Another viewpoint is that liquidity is a function of interest. If there is no interest in a stock, then trading will be minimal. However, the biggest reward from the market comes from discovering such stocks. If a stock's fundamentals are sound, then it is a scrip waiting to be discovered. And, whoever enters the stock first will most likely derive the maximum benefit.
Stocks such as EID Parry and Cholamandalam Finance are owned by a number of funds. But the relative illiquidity ensures that these are not the top picks of the portfolio. The market, however, is evolving and there are three funds (Sundaram Select Midcap, Franklin India Prima and Birla Midcap) that invest in relatively less liquid stocks such as the ones you have mentioned. If you are interested in a portfolio of such stocks, you could take a look at these funds.
Whether you should go through the mutual fund route or invest directly is completely your call. If you have the time, inclination and enough understanding of the market, you can buy shares on your own. On the other hand, if you are hard-pressed for time and value the convenience that a mutual fund offers, then investment in a fund will serve your purpose.
This article was originally published on May 08, 2003.
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