A few days ago I had written in this Blog that SEBI had asked AMFI to moderate its advertisement campaign Mutual Fund Sahi Hai. (Read Good News from SEBI – Mutual Funds Sahi Nahi Hai)  Well it appears that the Association of Mutual Funds of India (AMFI) has not acted, even though its President Mr. Balasubramanian has said they would act. While the advertising campaign continues in its original form, implicitly suggesting high and safe returns, there are newspaper reports that there is large scale mis-selling in various parts of the country, especially the smaller towns, promoting the balanced fund as a safe, high return, monthly income plan. One can only hope that innocent investors are not to subject to financial loss due to deliberate mis-selling by all involved in the mutual fund industry.

Business Standard (23/24 December 2017, Pune Edition), quoting unknown sources from an unknown large mutual fund says that while there has been a large inflow of funds to the mutual fund industry, there is no cause for concern. The unknown source mentioned that the industry has learnt its lesson from the 2008 crash and claimed that the mutual fund industry is much better prepared to meet any downside risks. He claimed that the key is investor engagement – meaning that investors should be educated on the risks of investing in mutual funds. The advertising campaign, Mutual Fund Sahi Hai does exactly the opposite. It does not educate the investor on the potential risks. Apart from using vague words to convey a perception, neither the article nor the unknown person have specified the exact steps taken to protect investors or to educate them. While unknown persons are saying everything is alright, fortunately known persons have started cautioning the public.

The Fallacy of Believing that Balanced Funds are Safe

One of the fallacies of the reported advice (See Business Standard, 23/24 December 2017, Pune Edition, page 6) coming from the mutual fund industry is asking investors to invest in balanced funds, with the implication that it is less risky and therefore more safe. This advice is based on the perception that equity markets are risky while debt markets are safe. A mixture of the 2 markets gives us the balanced fund.

Fallacy No.1

One fails to understand that when both debt and equity are risky how does the balanced fund become less risky? (Read in this Blog Are Debt Funds Really Safe?) The only condition when balancing a fund makes sense is when the debt and equity markets do not move up or down at the same time. If debt markets move up when equity markets move down, or vice versa, then the balanced fund balances the risks arising in different time periods. But there is little evidence to suggest that this will happen all the time. In fact right now the equity markets are booming and debt has also firmed up, debt yields are currently rising.

Fallacy No. 2

It is also important to know a little bit more about balanced funds other than what the term “balanced” seemingly implies. A balanced fund in practice can have any proportion of debt and equity. Some balanced funds may have 75 % equity and 25 % debt, while other balanced funds may have 25 % equity and 75 % debt. You can also have balanced funds with any other proportion of debt and equity.

A mutual fund with 75 % equity and a mutual fund with 25 % equity are not in the same risk class. But both are balanced funds and both are sold as being less risky. A mutual fund, where 75 % of the fund is invested in shares, is more likely to see a whopping loss in NAV when the share market crashes, than a mutual fund which has 25 % in equity. Beware of balanced funds! They are as unsafe as equity funds or debt funds. Know where the money in the fund is invested.

Beware of Ambitious Fund Managers

Another aspect in this respect you should know is that many fund managers are instinctively aggressive in their investment strategy. They want to “beat the index”. That is if the mutual fund is for example a multi-sector fund investing in large companies across many industry sectors, the fund manager will have a desire that his fund should get a return higher that the SENSEX returns, for example. To do so in a rising market, the fund manager is inclined to invest in small cap and medium cap shares. That is shares of smaller companies. The reason for this is when the market rises the share prices of the smaller companies rise faster. That is to say that a share that is priced at Rs. 15 is more likely to become Rs. 30 (double) in a short period, while a share priced at Rs. 800 is unlikely to double in the same short period. So by investing in smaller companies, the fund manager hopes to book high returns and “beat the index”. The problem with this is when the market crashes the smaller company shares fall faster and fall deeper. All profits booked in a rising market can be wiped off in a few days.

Keep Away from Funds Promoted as Beating the Index – You May Have to Beat Yourself Later

Hence it is not whether the mutual fund is categorized as balanced fund or not, the whole point is what is the percentage distribution of the fund holding amongst low risk and high risk categories, and in the high risk category (shares for example), what is the percentage distribution between smaller companies and larger companies.

As a matter of fact it is best to keep away from a fund that claims it has beaten the index – this is a dangerous mutual fund to invest in.

Simply Because it is called Balanced Fund Doesn’t Make it Safe

In smaller towns it is this balanced funds that investors are being asked to buy on the grounds that it is safe and also gives high returns. Business Standard (26 December 2017, Pune edition, page 6) reports “Mis-selling of balanced funds is rampant today”. Investors are being shown past payouts to unit holders, which are are 1 % per month or even more. Mr. Deepsh Raghaw, Founder, Personal Finance Plan is quoted in the article as saying, “Dividends can only be paid out of profits generated by a fund. As soon as markets witness a downturn, these returns will stop.” But as Mr. Jimmy Patel, Managing Director and CEO of Quantum Mutual Fund puts it, “Investing in a balanced fund that is being sold as a regular income product offering monthly dividend is not the right way to invest.”

Investors are being told that if the mutual fund has earned 15 % in the past, it will continue to earn at least that much in future too. But that is not true. The future is unknown. Prediction is risky. Neither the agent selling mutual fund nor the lay customer knows where exactly the money of the fund is invested. Questions that give the investor an idea of the risk involved are not even considered or asked. Questions such as

• Is the fund invested heavily in smaller companies (small cap and mid cap)?
• Is it invested in debt of companies that have have a low credit rating?
• Is it invested in companies that have defaulted banks in their payments (this information is not even available to the public)?
• What is the percentage of the money of the fund is invested in debt and equities?
• How much risk do you want to take as an investor?

Without knowing answers to questions such as these (and other similar questions, read in this Blog Are Debt Funds Really Safe? ,  Look Where Debt Funds are Investing) if one invests in a mutual fund, it is like tying a cloth over your eyes and trying to shoot a target with a gun. You will be lucky to not kill anyone.

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