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Birbal, Mughal Emperor Akbar's wisest counselor, had once proven to some feuding siblings that a bundle of sticks together was stronger than each stick individually. Similarly, I firmly believe that a concerted investing effort will prove wiser than a person investing individually.
Investing in the stock market has become as common thing as owning a mobile phone. The investing community can be divided into two types of people:
Everyone wants to adopt the 'me too' policy when it comes to stock market investing (especially when it is experiencing boom times), lest they are left out of a conversation at a social gathering. Even the soap-opera addict housewife has diverted some of her daily soap time to investing in stocks.
Just the other day I had an intense conversation with our local grocer on investing in stocks. The chat was one-sided: he did the talking, while I listened. The discussion meandered around his investment in the ITC scrip. He felt that being a reseller of ITC's products made him an expert on the stock itself.
Of course, he was sour that though the ITC products sell like hot cakes, the stock price apparently had gone down by 10% since he had bought it.
Investing in the equity markets is a tricky and time-consuming activity. Those who do have the time may not have the knack and more often than not, those who do have the knack most certainly don't have the time.
The ones with the knack are too busy with their daily professions to devote active time to investing activities and those who have the time may not be knowledgeable enough to understand the nuances of stock market investing. I am a strong believer that lay investors should leave the investing to market professionals who make their daily bread and butter from providing investment-related services.
Mutual funds and the recently popular portfolio management services (PMS) are two of some of the options available to the naïve investor. The world over, it is a common practice to invest into the stock markets through the mutual fund route. In the United States of America, mutual fund houses manage trillions of dollars of public funds.
Just a single fund house like Fidelity, which is one of the largest in the US, has over $600 billion of funds under management and over 300 funds on offer for clients. Fidelity is managed by the famous father-daughter team of Edward and Abigail Johnson.
Rationale
Economies of scale: Mutual funds have the might of volume. Since collectively they have a larger sum to invest as compared to an individual investor they can take advantage of economies of scale. They can average by buying further if the stock price has fallen as they have access to large amounts of funds.
Similarly, if the valuation is low they can also buy a large quantity and make a bigger profit when the price rises.
Performance over a longer period: Historically, if you study the performances of mutual funds over 30, 20 or even 10 years you will find that diversified funds normally beat the benchmark index. Even a simple 7 per cent compounded annual return would turn a Rs 1,000 (invested into mutual funds) into Rs 1,967 in 10 years, Rs 3,869 in 20 years and Rs 7,612 in 30 years. And this does not even count the dividends and any change in rate of return. If the fund returned an average of just 10% on an average, then Rs 1,000 in 10 years would be Rs 2,593, in 20 years Rs 6,727 and a sizeable Rs 17,450 in 30 years.
Informed investment decisions: Mutual funds focus only on market movements and related news -- both local and global -- and market data on a continuous basis. Because of this they are able to take quick and well-informed decisions as compared to a lay investor who may not have a broad outlook or access to information.
In-depth research: Mutual funds invest heavily into research and all the fund houses have a quality research team in place. Most of the investments are based on their recommendations. Yes, most brokers also provide valued research to their clients, but do all investors have the time to actually read and analyze these reports to make investment decisions?
Investment criteria: All fund houses have a broad set of parameters to weigh and filter the scrips which they can or will invest into. Following are some of the criteria fund houses use to filter scrips:
This system of filtering will weed out all the operator-driven, speculative stocks and the vast amount of stocks will get pruned down to quality long-term holds which will help enhance capital appreciation.
Performance-based remuneration: Most fund houses reward the better performing fund managers through hefty performance-based bonuses. This is a major incentive for the fund manager to perform better.
All these are just some of the reasons that one should look at investing via the mutual fund route. The government has not yet permitted capital guaranteed funds to be offered but they will be offered in the near future. These are extremely popular in the overseas markets.
I guess once people's capital is guaranteed then mutual funds would gain popularity with retail investors. Investing through systematic planning or the popular acronym for the same, SIPs (systematic investment plans) in mutual funds will yield good results over a longer term for retail investors.
The author is director, Jitendra Harjivandas Securities (P) Ltd, and a stock market expert.