VR Logo

Dangerous Times

These are great times for investors but these are also the times that demand the greatest caution. The hype is so loud and so convincing that it takes a very cool and balanced head to make the right decisions

It's a dangerous time for investors when any and every investment makes money. I do realise that I must be sounding like a lunatic when I say that. How can things be dangerous when money is flowing into investors' account statements as if it grew on trees? And for mutual fund investors, it does appear to be growing on trees.

Take a look at the worst-performing equity mutual fund of 2005, which is a scheme called LICMF Equity, run by the mutual fund arm of the Life Insurance Corporation. This fund gave investors returns of over 23 per cent during the year. The dangerous part of the story is that this fund (which returned an astounding 6 times what a bank savings account would return) was ranked 101st out of the 101 funds of this type that were in operation during the year.

What LICMF Equity fund proves that we have just lived through a year when it was virtually impossible to lose money on the stock markets, no matter how bad an investor you were. This fund's investment managers did worse than 100 of their 100 peers but those who had invested in their fund still made a lot of money.

Of course investors in the best funds made an absolutely humongous amount of money. The top fund of the year was Magnum Emerging Businesses, run by the mutual fund arm of the State Bank of India, and gave returns of 80 per cent over the year. All in all, an amazing 37 out of 101 funds gave returns above 50 per cent.

Something similar has been happening for stock investors as well. Even though there were some stocks that lost money, an overwhelming number of them went up by huge margins. There aren't really any stock or mutual fund investors out there who didn't make a great deal of money. Therefore, what we have here is like an examination which everyone clears because the passing marks have been reduced to zero.

These are abnormal times which are very dangerous precisely because it's impossible to make mistakes. You can invest in bad companies and bad funds and still make money. And that means that when the going gets even slightly tougher, a lot of people will find that they actually did invest in bad companies and in bad funds.

It's an old saying that more investment mistakes are made in good times than in bad times and since the times are so good right now, the potential for making mistakes is that much higher. Investment markets change direction very quickly. Nothing prevents what look like good investments today from turning out to be bad ones.

A large part of the money that is being invested by individual small and medium investors is in response to an active sales effort by mutual funds, portfolio managers and insurance companies. Investors are not going out, doing their own knowledge gathering and then choosing. Rather, there is a high pressure sales effort which is finding easy converts because the rise of the stock markets.

Unfortunately, this is leading to most investment going into those investments which bring the maximum profit to the salesman, rather than to the one most suitable for the customer. In mutual funds, almost all new money is going into new funds which do not have a track record rather than to tried and tested ones. The reason is that fund companies are allowed to take out five per cent of the money collected as marketing expenses. Since this can't be done with older funds, companies find it profitable to continuously launch new funds that are just minor variations of ones. The salesman who sells you mutual funds could possibly be making five times the normal amount for selling a new fund. No wonder his 'advice' is always for buying new funds.

As for misguided investments that result from the doings of insurance companies, the less said the better. Even though the insurance regulator IRDA has cracked down on the charade of very high-priced mutual funds--unit-linked plans--masquerading as insurance policies, for some reason it has given insurance companies time till April before they have to clean up their act.

Paradoxically, these are great times for investors but they are also the times that demand the greatest caution. The hype is so loud and so convincing that it takes a very cool and balanced head to make the right decisions.