Time to review ways we look at risk
A new mutual fund scheme files for launch with regulators. The offer document is carefully crafted so those applying for the new fund offer do not get an illusion of a guaranteed return. A risk-o-meter determines the risk level that the mutual fund scheme exposes potential unitholders of that scheme. The rating given is extremely high risk for a new fund called a multi-asset fund. Any equity fund that offers market-linked returns is subject to market risks. One has to read the offer document carefully before investing. If people read these offer documents carefully, they would wonder why they risk the money.
The idea of ensuring the highlighting of risk factors is to protect investors. However, here is the problem. You open a ‘demat’ account with a broker and put your money directly in stocks. Then, you also use the brokerage to borrow money against your investments. While the stock market system is protected through margins, you are at risk when borrowing money against a stock that could potentially lose value significantly.
When you subscribe to an initial public offering of a company, you do that because you know that a trusted promoter group promotes the company. You know the company’s product or service, and many of your friends and colleagues at work are doing the same. There is always an overwhelming response to a new share offer by a company that enjoys market credibility. However, that company will continue to do business for years to come and, if it is that good, will continue to deliver returns. You are supposed to stay invested and ride through market cycles to make any meaningful money out of that investment.
Then some want to outsmart the market. They use derivatives and other complicated securities to boost their portfolio. If you are an active investor, those are things beneficial for you to hedge your portfolio. You can add that bite to your short-term returns with the help of derivatives and potentially make money. When you use derivatives, you are speculating about the stock’s prospects. There is a downside to that. Many of you have learnt hard lessons in the market after the lockdown.
The purpose of mutual funds is to help individuals generate a long-term return on their investments. You are supposed to own equity assets through mutual funds and grow your savings into a meaningful corpus for your retirement or child’s education. These are not short-term plans. These are structured long-term ideas. You have to be a ‘buy’ or ‘hold’ investor. Mutual funds are supposed to encourage you to do that.
You can do the same by buying and holding shares of fundamentally strong companies like Warren Buffett, the famous American investor, however, when asked why nobody invests as he does. He said that nobody likes to get rich slowly.
Regulators need to review how they look at risk in an investment and how it is depicted in investor communication. Empirical evidence suggests that equity investing has never disappointed investors if they follow a long-term investment strategy.
The jurisdiction of the Securities and Exchange Board of India is limited to the intermediaries they regulate. Much money lies in fixed deposits of banks and companies, chit funds, physical gold or gold bonds and real estate. Then there are a plethora of endowment plans promoted by insurance companies. These come under either the Reserve Bank of India, the Insurance Regulatory Development Authority of India or the ministry of corporate affairs. Each one promotes risk awareness based on the product category they regulate. That confuses everybody about the risks associated with investments.
All regulators need to get together and create a consolidated risk-o-meter across financial products and asset classes. Diversified equity mutual funds carry relatively less risk than owning equity directly. A multi-asset fund should be a step below the diversified equity fund, as you own more than one asset class. That way, your risk is spread across markets.
Mutual funds generate long-term returns
The purpose of mutual funds is to help individuals generate a long-term return on their investments. You are supposed to own equity assets through mutual funds and grow your savings into a meaningful corpus for your retirement or child’s education.
Rajas Kelkar
(The author is editor-in-chief at www.moneyminute.in)