How to Invest in Mutual Funds in Indian Markets?

How to Invest in Mutual Funds in Indian Markets?

When you get down to investing in mutual funds, there is a problem of plenty. With more than 40 AMCs, over 2000 schemes and with each scheme having a growth or dividend option along with a Regular Plan and a Direct Plan, you can imagine how complex it gets. Your screeners on the website can help you up to a point but you still need to narrow down to the scheme that best suits your needs. That is where this process will come in handy. Before you make your choice of fund, go through the following process.

Narrow down to funds based on AUM

A small fund with a corpus of Rs.100 crore may be the best performer but the fund business may be hard to sustain for them. Such funds are best avoided if you have a long term perspective. You must ideally stick to larger funds that have been around for over 15-20 years in the business. Such funds and fund managers have gone through cycles in business. Also, a higher AUM reduces your expense ratio as it gets spread over a large corpus.

In equity funds, prefer diversified funds over thematic funds

The whole idea of investing in mutual funds is to get the benefit of diversification. Don’t let go of this benefit by selecting thematic funds. The last thing you want is the fund manager to introduce concentration risk into your portfolio. This rule applies to equity funds and to debt funds also. While equity funds must diversify across sectors, business models and quality; debt funds must diversify across quality, tenor, duration etc.

Select funds that are consistent as they are more predictable

Two funds may have given the same CAGR returns over 5 years but you must look at the consistency. A fund that has given annual returns around the CAGR is better than the fund that has given super returns in 2 years and negative returns in 2 years. When you buy an inconsistent fund, timing becomes too critical. If you get in one of their super years, you may be disappointed at the end of 5 years. That is why consistent funds are a lot more predictable and reliable.

Is it the fund manager skill that is rewarding you?

An equity fund manager has to be better than an index fund manager. At the same time you cannot have a fund manager with the risk appetite of a seafarer. But how do you verifiably measure this? A simple method is the out performance of the fund returns over benchmark index. But that tells you only one side of the story. If the fund manager has outperformed by taking on too much risk then the fund manager is not working hard enough. Sharpe ratio and Treynor ratio can calculate risk-adjusted returns. You can also use the Fama coefficient to measure whether the fund manager is generating returns out of his stock selection skill or through pure luck.

Check our SIP calculator and Lumpsum calculator before planning your mutual fund investment

Cost efficiency is the next thing to look at

Expense ratios on equity funds range from 2.50% to 2.75%. If you can save on these costs it can make a substantial difference to your returns in the long run. When you calculate the cost of the fund, include all relevant costs and that includes the TER as well as the exit load. Some funds may charge a lower TER but have a higher exit load. Such funds can become very expensive when you exit before the 1 year period.

Mutual fund must fit into your financial plan

In fact, your activity must begin with a financial plan and these mutual fund investments must fit into the plan. The question you need to ask yourself is, “Is this fund good enough for me”? Look at every fund from the perspective of your own goals; your return requirements, your risk capacity, tax status and liquidity needs. It is only when you apply this litmus test that the effort of navigating through a plethora of mutual funds actually becomes meaningful for you.

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Do’s and Don’ts of Stock Market Investing for Beginners

Do's and Don'ts for beginners

With a trading account and demat account you are ready to trade. But if you are a beginner in the stock markets, then that is not all. You also need to keep a tab on some major do’s and don’ts before you venture into investing in the stock markets. Let us look at 10 such key dos and don’ts for investors.

10 important do’s and don’ts for investment beginners

Do’s are about doing the right things in the market when you are starting off on your investing journey while the don’ts are the ones to avoid. Here are ten such important dos and don’ts for investing beginners.

  1. Do your research before investing? Remember, research of a stock is not a rocket science and it is all about getting your research process right. Get comfortable reading the balance sheets and income statements of a company. Also read the Management Discussion and Analysis (MDA) of the stock you are planning to invest in.

  2. Start with your goals in mind. You must be clear about how much risk you are willing to take and how much risk you can afford to take. Your equity portfolio should be within the limits defined by your allocation. Always start with a plan.

  3. Don’t put all your eggs in one basket. That is age old wisdom and applies to investing as well. In technical parlance it is called diversification where you effectively spread your equity investments across sectors and themes so that your investment performance is not dependent on any one stock or sector.

  4. Take a long term view and cultivate that habit in the very beginning. It is futile to time the market. Not only that it is hard to consistently get the tops and bottoms of the market right but it hardly makes any difference to your eventual returns.

  5. Try to invest consistently and regularly instead of putting a large corpus in a stock of your choice. The advantage of being regular is that it instils discipline in your investment and also gives the added benefit of rupee cost averaging. That means; over time your average cost of investing comes down.

  6. Even through equity is about the long term, try to get bargains. Even if you are convinced about the long term prospects of Infosys, it makes a lot of business sense to buy at Rs.650 than at Rs.750. Quite often, a market correction creates salivating bargains. Use such corrections to add quality stocks at low prices.

  7. Divide your equity portfolio between core holdings and satellite holdings. Your core holdings are your long term investment portfolio and you don’t sell these stocks at every correction. On the other hand, the satellite portfolios are more of a trading portfolio where you look out for short to medium term opportunities in the market. Have a separate approach to both these types of stocks.

  8. Don’t ignore trading costs. Even if you are a long term investor, take at a close look at your costs. Your cost is not just about brokerage costs but there are a number of other costs too. There are statutory costs, exchange charges, demat AMC, DIS charges, demat and remat charges etc. All these need to be added to calculate your effective cost. Nowadays, it makes a lot of sense to opt for low-cost discount brokers who can give the same execution at a much lower cost.

  9. As a beginner, remember that quality always wins in the end. When we talk about quality we are talking about quality at a number of levels. Look at quality of earnings; more of the earnings must be coming from the core business. Look at profitability; the company must be earning more margins than the peer group. Take stock of asset turnover; it tells you how efficiently the business is using assets. At a qualitative level, prefer companies that have high standard of disclosure and transparency. Large caps or mid caps, this quality approach always works in your favour.

  10. Make effective use of technology and if you are a beginner then you better get used to it early. Ideally use the online trading platform; it gives you a lot more control over your trades. Also, if possible you can download the app on your smart phone which allows you to trade on the run. Get used to reading electronic contract notes and ledgers; they are a lot more convenient and environment friendly than printed stuff.

In an effort to chase stocks, investors tend to forget that investment success is a lot more about discipline than about skills or flair. It is in your hands to make your investments work in a systematic manner.

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5 Tips for Investing in Initial Public Offerings (IPO)

5 Tips for Investing in Initial Public Offerings (IPO)

Between 2015 and 2018, IPOs became a principal source of raising funds and also an interesting avenue for investors to park their funds. IPOs like Alkem, Avenue Supermarts and Shankara Building Products, among others, did extremely well post listing. However, the IPO market also had its share of disappointments. How to separate the good IPOs from the mediocre IPOs, remains the million dollar question. Here are five tips to help you invest in IPO offerings.

Don’t invest in IPOs without checking the background of the promoters

This may look intangible but pedigree of promoters matters a lot. If the promoters have a past record of destroying stock market wealth or of corporate governance issues, such issues are best avoided. Irrespective of the attractiveness of the business, a bad management can do a lot of damage. Look at Satyam versus Infosys in the same industry. Quality of promoters has a direct bearing on the valuations of a company and the performance of an IPO. More often than not, it is the promoters who make the difference between a bad company and a good company.

Valuations matter because you cannot pay too much for IPO hype

When we talk of valuations, it is not just about P/E ratio but more about P/E ratios with reference to the growth of the company. For example, Avenue Supermarts was richly valued even at the time of the IPO. Despite that, the company gave more than 200% returns post listing. Be cautious when promoters and anchor investors try to use the IPO to exit their holdings in the company at rich valuations. You don’t have to play ball in such cases.

Utilization of funds tells you a lot about the quality of the IPO

In the IPO prospectus, the utilization of funds is clearly laid out. It is always good to focus on IPOs that utilize a bigger share of the IPO resources in enhancing their core business. For example, if a manufacturing company is using the IPO funds to expand its scale or to make strategic diversifications then it is a good idea. This will enhance the long term prospects of the company. You must be doubly cautious about investing in IPOs where the bulk of the IPO proceeds are going into meeting working capital needs, investing in real estate properties, investing in group companies etc. Some companies also use IPO proceeds to repay high cost loans. While that is acceptable, investors must remember that equity has a higher cost compared to debt.

Be wary of IPOs where promoter is substantially diluting stake

Quite often you come across IPOs that also have an OFS (offer for sale) component. Here the promoter or the anchor investor looks to monetize part of their stake as part of the IPO. This is true for companies promoted by large institutions as well as entrepreneurs. This is perfectly understandable. However, you must be wary of companies where promoters have been trying to consistently dilute their stake in the company. This is not a good sign at all. Promoter stake in the company post IPO is a signal of their continued commitment to the company and its business. Remember that promoters can also pledge shares and that can also result in forced reduction of promoter holdings. All these are red flags to look out. You invest in the promoters as much as in the business so you need promoters committed to the business in the long term.

Be wary of too much debt or too much equity

In the last 11 years since the financial crisis, the worst performing IPOs are the ones that got into too much debt. Companies with high debt levels will always have a solvency problem and that puts a limit to the wealth that they can create. This is more so in industries that are cyclical in nature as in the case of metals and infrastructure. There is financial risk in debt and that is where most mid-cap and even large cap companies falter. Just as too much debt is bad, too much equity also makes the company languid.

The next time you invest in an IPO, watch out for these five things. It is a good starting point!

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What is ELSS Funds and How they are Helpful for Tax Savings?

What is ELSS Funds and How they are Helpful for Tax Savings?

ELSS fund or Equity Linked Savings Scheme fund is a tax-saving scheme that derives their returns from the equity market. The ELSS funds come with a lock-in period of three years. The investor cannot withdraw from the ELSS scheme during this duration. The ELSS fund gives twin advantage of capital appreciation and tax benefits.

The ELSS funds are mostly open-ended mutual funds. They help the investor to save tax under the Section 80C, and the taxable deduction available for this investment is upto Rs.1,50,000. The ELSS funds are suitable to inculcate the habit of saving among investors as the lock-in period prohibits the withdrawal of the investment for three years.

The ELSS comes with a low investment threshold of Rs.500 and the investor need not make a one-time investment for ELSS.  They can opt for the Systematic Investment Plan(SIP) method where they will invest a pre-set amount on a specified date of every month or six months. Through the SIP method, the investor has the option to spread their investments over the year, and this saves the last minute rush for searching for investments that help in tax savings.

However, when the investors opt the method of SIP payment, they should be aware of the fact that every SIP payment is considered as a fresh investment and it has an individual locking period of three years. The ELSS funds are the only investment with a low lock-in period of three years when compared to other tax saving investments.

When calculating SIP for the ELSS investment, the investor has to make sure that their investments are spread over the year. The investor has to use this simple formula to arrive at their SIP calculation

The ELSS funds come with two options for Growth and Dividend. The investor can choose the option that aligns with financial goals.

Growth option:

In this option, the investment along with its profit is accumulated, and the total amount is paid to the investor at the end of the lock-in period with an option of reinvestment.

Dividend Option:

The dividend option comes with two choices of dividend payout and dividend reinvestment. In dividend payout, the investor will receive the payment of a dividend from time to time. In dividend reinvestment, the payout is reinvested, and it will be treated as a fresh investment with the benefit of a tax deduction

The tax saving feature of ELSS funds:

Under Section 80C of the Income Tax Act,1961 a tax payer can claim up to Rs.1,50,000 as relief against their investments. Under the new budget rules, the long-term capital gains (for investments held more than one year) exceeding more than Rs.1,00,000 are subject to 10% tax without benefit of indexation.

The ELSS funds are the best option as tax saving investments as they have the power to give benefits of high returns with the flexibility of investment and the lowest lock-in period when compared to other investments.

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How to Prepare for Next Bear Phase in Stock Market?

How to Prepare for Next Bear Phase in Stock Market?

What exactly do we understand by a bear phase in the stock market? While there is no hard and fast definition of a bear market, the accepted standard definition is a correction of 20% from the peak of stock market. It is normal for stock broker and investors to panic in the face of a bear market and act instinctively. The result is that you end up losing opportunities which the bear market offers. Bear markets are not about jumping in and buying every stock that has corrected. Here is how you can prepare for a bear market.

Remember, bear markets are always more severe on some sectors

If you look back at the bull markets of the last 25 years, then the bear markets subsequent to such rallies have followed a similar pattern. The maximum damage has happened in stocks that triggered the rally in the first place. Post 1992, it was the cement pack that corrected the sharpest. Post the technology rally in 1999 even frontline stocks like Wipro and Infosys corrected more than 75%. Much worse was the damage to realty and infrastructure stocks post 2008. Most of the stocks lost over 95% of their peak value. As a strategy, prepare to exit the drivers of the bull rally first in any bear market. Such stocks are not meant to be bought on dips. This is the basic rule that should guide stock broker strategy in the bear phase of stock market.

Stay low on leveraged positions in the market

The problem with bear markets is that they are also accompanied by a rise in volatility and a fall in buying demand. This widens the spreads on stocks. In the markets, you can be leveraged in two ways. You can either borrow to invest or you can trade on margin. In both cases, bear markets are the time to cut down on your leveraged positions. Even if your view is right, the spurt in volatility may trigger stop losses. Minimize your leveraged positions in a bear market as it can draw you into a vicious cycle of trading losses.

Look for asset classes beyond equity

More often than not, we end up believing that equities are the only place to invest and end up making wrong decisions. There are asset classes beyond equity that can protect value in bad times. For example, gold has typically done very well when equity markets have fallen. Similarly, liquid funds and debt funds can also give much more stability to your portfolio. Even within your equity portfolio, look to diversify across themes. If you spread your portfolio across themes and sectors, you stand a very good chance of doing well compared to putting all your eggs in one basket.

Bear market is the time to restructure and rebalance your portfolio

If you were waiting for the right time to change your portfolio mix, then for stock broker the bear stock market is the right time to rebalance and restructure your portfolio . As we said earlier, first get out of the stocks and themes that triggered the bull market in the first place. Shift your stocks from high beta names to low beta names. They will hold value much better. In any bear market, the mid caps and small caps face the maximum damage. You can prepare yourself by shifting out of such stocks well in advance. Focus more on companies that follow relatively higher standards of corporate governance and disclosure practices. They are likely to give fewer negative surprises in a bear market.

If we can just focus on these defences, bear markets can be easily and methodically handled!

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How to Secure your Portfolio Against Fall in Nifty?

How to Secure your Portfolio Against Fall in Nifty?

The Nifty chart over the last 18 years shows a secular up move in the index. However, within the overall trend, there have been bouts of severe volatility and sharp corrections. We have seen big corrections in the market in 2000, 2008 and 2013. The corrections have ranged from 20% in 2013 to as high as 62% in 2008. As an investor, it is not always possible to enter at the bottom and exit at the top because markets tend to be counter-intuitive. How do you adopt a systematic approach to securing your portfolio against a fall in the Nifty? There are some proactive solutions and some reactive ones.

Chart Source: Google Finance

It would be very simple to say that over the long run the Nifty has made profits. The bigger question is how to shield against short term volatility.

1. Time to reallocate – Buy into strength and sell into weakness

This is a cardinal approach to handling a correction. Even when the NBFC crisis broke out in late 2018, Dewan Housing corrected more than LIC Housing or Bajaj Finance. That is why, it is always essential to buy into strength and sell into weakness in a falling market because weak stocks become vulnerable. When you reallocate your portfolio, it has a cost but it would be smarter than just watching your portfolio depreciate. Quite often, investors use discrete options like averaging or exiting altogether. There is a mid-way approach.

Why are we talking about buying into strength? When the Nifty corrects, it separates the men from the boys. In 2000, technology stocks caused the crash. Over the last 18 years stocks like Satyam, Pentamedia, DSQ and many more vanished. But stocks like Infosys, TCS and Wipro have only emerged stronger. The rule is to exit frothy stocks immediately.

2. Seriously consider farming your losses for tax purposes

In India, tax farming is quite popular among HNI investors. If you are holding on to stocks and it is down in the last 6 months, you can book a loss and write it off against other gains. This reduces your capital gains tax liability. Now that LTCG is also taxed on equity, this can be applied to LTCG and to STCG. By farming losses, you don’t lose anything but the notional loss is converted into a real loss and reduces your overall tax liability. Even if you don’t have gains in this year, you can still farm these losses and carry forward for a period of 8 years.

3. Make the best use of hedging tools

The stock market offers you a variety of hedging tools. You can sell futures against your stock to lock in profits and keep rolling over. Alternatively, you can buy lower put options to limit you risk in a falling market; either in the stock or the index. You can even sell higher call options to reduce your cost of holding. In short, F&O offers you a plethora of opportunities to protect and also benefit from a falling Nifty.

4. A phased approach will be a good shield against a falling Nifty

The best of traders are not able to call tops and bottoms of the market consistently. When the market is falling, you normally believe that you have a choice between staying out and catching a falling knife. But there is a third option. You can adopt a phased and systematic approach to investing, at least till the time the volatility normalizes. Focus on managing your risk. One of the basic rules you must follow is to be true to your long term goals. They don’t need to be impacted by Nifty volatility and SIPs tagged to these goals must go on.

5. Keep liquidity handy to buy stocks at lower levels

A sharp correction in the Nifty can also offer bargains. But the trick is to ensure that you have liquidity in your hand when it matters. So, it is time to selectively roll your shopping trolleys out. You were happy to purchase HUVR at 1900 then why not at Rs.1500? A lot of quality stocks also correct in sympathy. Look for bargains and buy quality at cheap prices.

A falling Nifty calls for a mix of proactive and reactive actions to protect the value of your portfolio and make the best of opportunities. It is not too complicated!