While the past one year has been a boom period with most mutual funds returning exceptionally good returns, the other periods have seen moderate returns. So are mutual funds really worth while ?


Mutual funds are collections of monies placed by thousands of investors in an asset management company that then deploys these funds based on specific objectives and criteria to bring in collective returns for the investors. A percentage of the total funds normally 2-4% is assigned to the cost of managing the fund and these go towards the expense of the operations of the fund. The balance becomes the investment corpus that is then distributed by the fund managers with an objective to derive regular income or capital appreciation while balancing risks. Each fund would be guided by the principal objectives that are stated when the fund invites participation from investors.

Mutual funds deploy their corpus into the stock markets through both primary market (IPO) and secondary market investments as well as in fixed return securities such as government bonds, company papers and others. The proportion of investment is determined by the objectives of the fund. Funds are classified as Equity, Debt or Balanced and vary in risk and return. While the equity funds carry higher risks, they strive for higher returns. Debt funds invest in low risk and consequently low and fixed return instruments. Balanced funds try to provide a balance between these two.

Over the past year until May 2004, the mutual funds had a dream run that was not seen before in the Indian markets. Some funds saw an appreciation in investments of upto 160% in the twelve month period as the equity markets boomed and the BSE Sensex went from around 3000 points to cross 6000 at its peak.

This boom followed a 3 year drought that the markets experienced after the collapse of the markets in 2000. These three years saw very dismal returns to investors in most cases less than 5-6% each year.

So if you invested in the past year you would probably have reaped rich windfalls from your investment in mutual funds and if you have been investing for sometime you would just about have recovered some of your losses in the past year.

So the question really is : are mutual funds worth investing in ?

The answer to this is not really easy considering the past few years. However a look at the larger picture throws a different light.

Today we are at a stage where interest rates are at their lowest. The prime RBI rate is around 6.5% and this means that bank deposits do not bring in even this amount. The long term bank payout rate is about 6%. Inflation is now back at the 5-6% levels so you are really not making any money at all from your debt investments.

Real Estate is an option but the boom is over and the annual growth rates are now in the range of 10-15% annually. Gold and silver are too risky to invest in. They follow very volatile cycles and are difficult to track.

The next few years are expected to be a good period for Indian companies and their stocks. The economy has been growing steadily over the past few years and this growth and the competitive advantage that India has been gaining globally in industries like software, business process outsourcing, pharmaceutical, bio-technology and automobiles will show up in further growth over the rest of this decade. Other industries like textiles, garments and engineering are also following suit and are expected to boost export earnings. Agriculture that has been a laggard should also see better times with the new retail thrust on processed foods.

The area of political uncertainty is over for the present and the new government seems to be as committed to growth and opening up of the economy as the previous one.

In such a scenario, against the backdrop of the returns that other avenues of investment provide, mutual funds seem to be a good bet. There are no guarantees and the returns could turn out to be a mirage. It is however expected that the worst case will see funds delivering atleast what is the realistic return that we can expect from other instruments such as bonds and deposits.

It is important that we balance out our mutual fund portfolio to have a spread of fixed income and equity instruments. It is important to note that mutual funds are not only about equity. There are a number of funds that invest in fixed income schemes and strive to provide a steady income.

Depending on your risk profile, you could set aside some proportion of your total investment portfolio for mutual funds. Within this you could further divide your investments across many funds and apportion across higher risk equity and lower risk debt schemes.

For example you could say that 15% of your total investment portfolio will be invested in mutual funds.

Of this portfolio, you could assign 40% into equity schemes and 60% into debt schemes.

Chances are that the debt schemes will provide a return that is atleast equal to the deposits you have. The equity schemes could either provide you a higher return or come closer to the debt rate.

Since only 40% of 15% ie 6% of your total investment portfolio will be subject to this risk, you might not lose too much. You might however gain in the event of the markets doing well.

All said and done, mutual funds are managed by a professional team that has large investible funds at their disposal and are qualified for this area, far better than we are as individuals. They do this as a whole time career and spend a lot of time in research and analysis. They would therefore be better equipped to handle money markets than we would be with the limited time that we have.

It might be therefore good to maintain some portfolio in mutual funds. Mutual funds are not short term investment avenues and generally deliver returns only when spread over a medium term of 2-3 years. The next 2-3 years should see steady growth in our economy and the capital markets and therefore mutual funds might just deliver.