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  • Mar 16, 2001 - Lessons for the mutual fund investor in the Year 2000

Lessons for the mutual fund investor in the Year 2000

Mar 16, 2001

Equity markets are riddled with risk. Quite often we have seen uncertainty in the markets totally baffle the investor. That is why its important for you to have a strategy in place to counter uncertainty in the markets. But first you need to understand a few concepts about asset allocation. Year 2000 challenged a very important concept in asset allocation, i.e. of risk and return. Even a student studying financial investment and planning will tell you that return on an investment must be commensurate with the element of risk involved in holding that investment. According to the concept of risk-return, holding a bond (or a bond fund) will be less rewarding for the investor, as the risk of holding a bond is relatively low, given that bonds are ‘secured debt’. Similarly, equity investments, be it in stocks or mutual in funds, rank high on the risk spectrum given that equities are risk capital not secured by any collateral. So the return on an equity investment must justifiably be higher, than say a bond investment.

"Justifiably higher" are the operative words in the last sentence. However, while bonds are relatively predictable and follow a set pattern in line with interest rates, stocks have a mind of their own. In other words, stocks do not feel it necessary to follow any risk-return concept. They have no compunctions about exploding what they feel is just a myth.

In any case, this is exactly what happened in Year 2000, when the principle of risk-return was turned on its head. Investors in equity (or growth) funds were a disillusioned lot, because although they took more risk, they were not rewarded commensurately. But what must have put off growth fund investors even more is that debt (or income) fund investors posted higher returns over the last twelve months vis-à-vis equity funds. This is despite the fact that income fund investors take lower risk and must be rewarded accordingly. But as we said, stocks don’t really abide by such trivial principles of risk and return, which is exactly what makes them so risky.

Open ended Income Funds NAV(Rs) 1-month 3-months 6-months 12-months Inception
PNB Debt Fund (Gr) 12.9 2.2% 7.4% 11.3% 20.3% 15.9%
KP Childrens Asset Plan 14.0 1.0% 6.6% 8.8% 13.6% 14.4%
Templeton India Inc. (Gr) 16.7 1.7% 5.3% 8.4% 12.0% 13.7%
K Bond (WP)(Gr) 11.9 2.1% 5.6% 9.4% 12.0% 13.7%
Zurich India High Int.(Gr) 16.0 1.8% 5.1% 8.4% 11.8% 12.7%
LIC Bond Fund (Gr) 12.7 1.7% 4.3% 17.2% 11.8% 13.9%
Pru ICICI Inc. (Gr) 13.8 1.5% 4.6% 8.1% 11.6% 12.7%
KP Inc. Builder Acc. (Gr) 16.0 1.8% 4.9% 8.5% 11.6% 13.4%
DSP ML Bond Fund (Gr) 16.0 1.8% 5.1% 8.6% 11.5% 12.8%
UTI Bond Fund 13.9 1.8% 4.4% 7.7% 11.4% 12.5%

Over the last twelve months, income funds clocked gains as high as 12%. The debt markets were relatively stable during the year, except for a brief spell of volatility when the Reserve Bank of India (RBI) hiked the bank rate by 1% to 8% in July 2000, sparking off large-scale confusion in the debt market. Nevertheless the markets recouped admirably after that, and this was evident from the performance of debt funds, year-on-year.

Open ended Growth Funds NAV(Rs) 1-month 3-months 6-months 12-months Inception
JM Basic Fund 16.0 3.7% 17.9% 5.6% 72.4% 30.5%
DSP ML Opp. Fund (Gr) 8.1 -14.3% -10.8% -20.4% 0.0% -8.9%
HDFC Growth Fund (Gr) 8.0 -12.7% -18.9% 0.0% 0.0% -19.2%
IDBI-PRINC. Growth (Gr) 9.4 -13.0% -8.3% 0.0% 0.0% -7.2%
K MNC Scheme 8.9 -6.6% -6.1% -15.0% 0.0% -4.6%
Sun F&C Resurg. IEF (Gr) 10.1 -7.5% 0.5% 3.0% 0.0% 4.5%
Zurich(I) Capital Builder (Gr) 11.3 -6.7% -5.3% -14.2% 0.0% -18.0%
GIC D'MAT 7.9 -8.0% -3.8% -8.4% -15.7% -22.0%
Templeton India Growth 12.0 -10.9% -4.7% -9.1% -18.6% 6.8%
Birla MNC Fund (Gr) 27.7 -6.7% -7.4% -15.6% -19.0% 17.5%

Compared to income funds, equity funds performed most dismally. A combination of the tech meltdown and market volatility proved to be the undoing of most equity fund managers. Again this is more than evident from the returns equity funds have given over the last twelve months.

Open ended Gilt Funds NAV(Rs) 1-month 3-months 6-months 12-months Inception
JM G-Sec Fund (PFP) (Gr) 12.9 2.7% 8.9% 13.5% 18.5% 19.7%
JM G-Sec Fund(RP)(Gr) 12.7 2.2% 8.1% 12.2% 16.9% 18.0%
Templeton India Govt. Sec. (Gr) 13.1 2.5% 8.3% 12.5% 16.0% 17.3%
DSP ML G-Sec. Fund A(Gr) 12.6 2.9% 8.4% 12.8% 15.2% 17.2%
Tata Gilt Sec. Fund B (App) 12.7 1.5% 6.3% 10.7% 14.0% 17.2%
Pru ICICI Gilt(IP)(Gr) 12.5 2.2% 6.9% 11.1% 13.7% 15.3%
Birla Gilt Plus (LTP)(Gr) 12.4 2.6% 8.0% 11.6% 13.7% 16.8%
K Gilt Serial 2007 (Gr) 12.2 2.3% 6.5% 10.7% 13.7% 16.0%
Dundee Sov. Trust (Gr) 12.7 3.1% 8.2% 11.9% 13.5% 14.6%
K Gilt(IP)(Gr) 13.3 2.3% 6.9% 10.5% 13.4% 13.8%

Even income funds investing in government securities (gilt funds) have outperformed equity funds over the last twelve months. This is truly amazing, as government securities have no credit risk and are at the lowest end of the risk spectrum. This means that returns on a gilt fund should be the lowest of all, even lower than income funds and certainly much lower than equity funds. But that hasn’t happened, again disproving the risk-return principle.

So what’s the strategy for the mutual fund investor in Year 2001. Year 2000 should serve as an important pointer in this regard. Equity markets are still very volatile and there is no discernible trend as yet. Of course the one unmistakable trend is the meltdown in tech valuations and a surge in old economy stocks. But most funds are still wary of the markets (although they won’t admit the same in public) and one leading private mutual fund informed its investors that they should look at returns in the range of 20-25% in 2001. The interest rate scenario looks very stable and there is very little concern of an interest rate hike in the near term. This implies that debt funds and gilt funds could see a repeat performance in this year.

Investors with adequate appetite for risk would do well to invest in balanced funds with a 55-60% equity allocation (debt accounting for the balance). Given the sterling performance posted by debt funds and gilt funds in 2000 and with all indications of a repeat performance in 2001, investors may want to enhance exposure to income funds, even at the expense of growth funds. Of course, investors with a larger appetite for risk can take increased exposure to equity funds. But they must not forget the lessons learnt in 2000 – higher risk does not always mean higher returns.

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