Wednesday, September 24, 2008

Types of equity Mutual fund

In the increasing complex universe of types of equity funds, Investors are confused more often with their equity mutual fund portfolio.So before trying to device ones equity portfolio, lets analyse what are the most basic types of equity mutual fund available in the market.

1. Capital appreciation Funds

A mutual fund that attempts to increase asset value primarily through investments in growth stocks. The heavy investment in growth stocks increases the risk associated with these types of funds. This is sometimes called as "aggressive growth fund".In these funds manager have the leeway to buy any and all kind of stocks and are not forced to adhere any particular philosophy. The Fidelity Magellan Fund perhaps the world’s best known actively managed mutual fund is one in this kind.

2. Value funds

An equity mutual fund that primarily holds stocks that are considered to be undervalued Both with respect to their earnings and book value and that are likely to pay dividends. To know more about value funds please go through the article “what are value funds”

3. Quality Midcap and Large Cap Growth funds

A diversified portfolio of stocks that has capital appreciation as its primary goal, with little or no dividend payouts. Managers primarly invest in medium sized and large companies that are well established. They mainly consist of companies with above-average growth in earnings that reinvest their earnings into expansion, acquisitions, and research and development.

Investing in growth funds requires a tolerance for risk and a holding period with a time horizon of Eight to 10 years. Though this similar to Capital appreciation fund,the full control of the fund is not given to the manager. Manager just can’t suddenly hold 20% of the fund in a single company on which he bets as in the case of Capital appreciation fund.

4. Emerging leaders Growth fund

These are the funds which seek long term capital appreciation from investment in a portfolio of stocks across all market capitalization range. The portfolio may include those companies mostly small companies operating in emerging sectors of the economy or companies which exhibit potential to become leaders of tomorrow.

5. Special situation

These are the funds in which manager invest in stocks of companies that have nothing in particular in common except that something unique has occurred to change their prospects. An investment made due to a special situation is typically an attempt to profit from a change in valuation as a result of the special situation, and is generally not a long-term investment.

One of the condition in which of special situation that would prompt investors' attention would be a large public company spinning off one of its smaller business units into its own public company. If the market deems the soon-to-be-spun-off company to have a higher valuation in its present form than it will after the spinoff, an investor might buy shares in the larger company before the spinoff in an attempt to realize a quick price increase.

6. Broad Index based Fund

These are the funds which tracks some of the well known benchmarks.

Like S&P 500 , BSE 500, Wilshire 5000 Composite Index. We have already seen the details of investing in Broad Index based Fund here.

What are value funds???

An equity mutual fund that primarily holds stocks that are considered to be undervalued both with respect to their earnings and book value, and that they are likely to pay dividends.

Most of the holdings in value funds hover around a less p/e ratio usually around (4 – 15). The book value of the holdings might more than 1.5 times the stock price though this can be a characteristic of an undervalued company, this is not the sole feature that astute value investors seek.

Most of the prominent and well established mutual fund family has a value fund component in which funds are often broken down by size. Where a fund family may include small-, mid- and large-cap value funds for investors to choose from. The premise of value investing is that the market has inherent inefficiencies that enable companies to trade at levels below what they are actually worth or otherwise called as Intrinsic value of the company. In theory, once the market corrects these inefficiencies, the value investor will see the share price rise.

Tuesday, September 23, 2008

Use all Five Asset Classes to Build your Portfolio

Common people have a wide range of questions when it comes to the question of assets. What are assets? How many kind of asset classes are there?

Assets are certain investments in which your money works for you and earns you more money; you know that human potential of earning money is limited. If you like to have more money what you will do? May be you put more efforts and work for one more hour. Initially you will start working one hour extra; eventually you feel that even if you work 24 hours a day and 7 days a week all the efforts you put won’t gives gets you enough satisfaction.

This is where assets come into play for your rescue. Each penny you put into your asset class is a working horse, which is going to work 24 hours a day and 7 days a week.
The simple mathematical formula what it uses is compound interest.

Financial professionals generally agree there are five broad classes of assets.
The classes are:

1. Stocks or equities
2. Fixed Income or bonds
3. Money market or cash equivalents
4. Real estate or other tangible assets
5. Gold and Jewellery

So these are the classes of assets you have available to build your portfolio.
Each asset class have its own role and advantage, so a portfolio that only contains one or two above mentioned asset classes is not diversified and may not be prepared to take the full advantage of generating money in this dynamic world.

Sunday, September 21, 2008

Don’t try to beat the Markets!!!

I would like to start this topic with the famous Quote .

"Talking about beating markets is irrelevant and extremely boring."
- Rex Sinquefield , Co-Author Stocks ,Bonds,and Bills ,Chief Investment Officer,DFA.


Every Investor scratches their head before choosing an equity fund and always there's a general imbroglio, seeing the various varieties of funds prevailing in the Market. All the time and effort that people devote to picking the right fund, the hot sector , the hot hand, the great manager, the best performing fund have in most cases led to no advantage. Unless your fortunate enough to pick one of the few funds that consistently beat the average, that makes your research futile.

Though most of the people won’t agree with this, asking to themselves that ,how a Fund manager who got graduated from Harvard won’t be able to choose stocks which can outperform the market at least? Keeping this in mind most investors simply buy a fund that has been going up fast, on the assumption that it will keep on going. And why not? Psychologists have shown that humans have an inborn tendency to believe that the long run can be predicted from even a short series of outcomes. What’s more, from our own experience that some bowlers are far better than others bowlers in cricket, that some baseball players are much more likely to hit home runs, that our favorite restaurant serves consistently superior food, and that smart kids get consistently good grades. Skill and brains and hard work are recognized, rewarded—and consistently repeated—all around us. So, if a fund beats the market, our intuition tells us to expect it to keep right on outperforming.


Unfortunately, in the financial markets, luck is more important than luck is more important than skill. If a manager happens to be in the right corner of the market at just the right time, he will look brilliant—but all too often, what was hot suddenly goes cold and the manager’s IQ seems to shrivel by 70 basis point A famous study in the financial world is Efficient market hypothesis(EMH) which sates that , It is impossible to consistently outperform the market by using any information that the market already knows, except through luck. Let’s remember the analogy of warren buffet "Tossing the coin"


So what we just want to make you sure is, If we have any idea about beating the market by choosing the best fund by the information we get, that is almost going to be futile. But this doesn’t mean that we are going to lose our money, a fund can offer excellent value even if it doesn’t beat the market—by providing an economical way to diversify our holdings and by freeing up our time for all the other things you would rather be doing than picking our own stocks.

Financial scholars have been studying mutual-fund performance for at least a half century, and they are virtually unanimous on several points:

1. The average fund does not pick stocks well enough to overcome its costs of researching and trading them;

2. The higher a fund’s expenses, the lower its returns;

3. The more frequently a fund trades its stocks, the less it tends to earn;

4. Highly volatile funds, which bounce up and down more than average, are likely to stay volatile

5. Funds with high past returns are unlikely to remain winners for long.

So the bottom line here is:

Instead of concerning ourself with the daily ups and downs of the market, one ask himself a couple of very important questions: why should we try to beat the market? After all, can it even be done? Wall Street is very anxious for you to take the beat the market approach, also known as active management. Wall Street wants you to trade and keep trading as often as possible, because that’s how it makes money.

Saturday, September 20, 2008

The best way to own common stocks is through an index fund

I would like start this topic with 3 great Investment quotes which supports the index fund (Passive management).


The best way to own common stocks is through an index fund
-Warren buffet



Why Pay people to gamble with your money
-William F. Sharpe , Nobel Laureate for economics


Wall street's Favorite scam is Pretending Luck is skill
-Ron Ross, PhD., The Unbeatable Market


So before going into the Index funds, Let’s look back the history of actively managed Equity funds. First let’s take the Wall Street and analyze how many of the actively managed Equity funds had outperformed the Vanguard 500 Index fund people who don’t know what’s Vanguard 500 Index fund.

One year:
1,186 of 2,423 funds (or 48.9%)

Three years:
1,157 of 1,944 funds (or 59.5%)

Five years:
768 of 1,494 funds (or 51.4%)

Ten years:
227 of 728 funds (or 31.2%)

Fifteen years:
125 of 445 funds (or 28.1%)

Twenty years:
37 of 248 funds (or 14.9%)

This data clearly shows that in a long run equity funds opens the way to Low cost index funds.
Since because of the funds high expense ratio and bad behavior, most funds fail to earn their keep. The high returns generated by the funds always vanish in a long run. What’s more, as time passes, the drag of their excessive expenses leaves most funds farther and farther behind.


Let’s do one more analysis. Instead of taking Wall Street let’s take Dalal Street. When I thought of making this statistics, I could able to find only around 30 Equity Funds which is having a existence more than 10 Index. So I considered the basic years, and to our chagrin there is no other Index fund which tracks BSE 500 assumption that Index funds would almost replicate the performance of its Index with a very small have Tracking Error.



In the chart above , I haven’t included all the 30 Equity funds; rather I picked around 16 funds though the funds what I haven’t included almost 99% lost to the BSE 500 Index. These data points again stress that in a long run equity funds opens the way to Low cost index funds because of their low management fee and trading costs.

What, then, should the intelligent investor do?

First of all, recognize that an index fund- which owns all the stocks in the market, all the time, without any pretense of being able to select the “best” and avoid the “worst”—will beat most funds over the long run.

Consider this. If stocks generate, say, a 7% annualized return over the next 20 years, a low-cost index fund which tracks S&P 500 or BSE 500 index will return just under 6.7%. (That would turn a Rs 10,000 investment into more than Rs 36,000.) But the average stock fund, with its 1.5% in operating expenses and roughly 2% in trading costs, will be lucky to gain 3.5% annually. (That would turn Rs10,000 into just
Under Rs20,000—or nearly 50% less than the result from the index fund.)
This is surely a paradox. All the investors should realize this.

The most important thing is, one should take the broad category of index for comparison like S&P 500 or BSE 500 index because this gives you ample diversification and the growth from all broad categories..So just don’t see the index fund which tracks just 30 or 50 or even 100 stocks. Most of the Indian Index fund tracks the BSE Sensex (30) or a Nifty (50) stock which is not going to help us.

Once Buffet quoted a famous analogy about active investing, consider that tomorrow 225 million people in America with each having a dollar, comes out and tosses a coin and those who tossed a tail had to give his dollar to the person who calls a head. Eventually after repeating the process many times there is one guy standing who has a track record of always tossing heads, had made a single dollar to 225 million dollars. From the very next day he writes books how to turn a dollar to 225 million dollars..
Everyone starts to speak about him, and follows him and boasts him.


Index funds have only one significant flaw, they are boring. You’ll never be able to go to a show off and brag about how you own the top-performing fund in the country. You’ll never be able to boast that you beat the market, because the job of an index fund is to match the market’s return, not to exceed it. Your index-fund manager is not likely to “toss a coin” and gamble that the next great industry will be the technology or Banking, or telepathic weight-loss clinics; the fund will always own every stock, not just one manager’s best guess at the next new thing. But, as the years pass, the cost advantage of indexing will keep accruing relentlessly. Hold an index fund for 20 years or more, adding new money every month, and you are all but certain to outperform the vast majority of professional and individual
investors alike.

I do accept that each year 1/3 of the funds beat the Market , But each year they are different.

Friday, September 19, 2008

How to choose an Equity fund !!!!

How to choose an my Equity fund !!!! This is the one question which always comes to the mind to an investor. Will my fund beat the Index??
Yes certain funds do... what qualities do they have in common ???

1. They are cheap.

One of the most common misunderstanding is "Higher returns are the best justification for higher fees" . But in the financial world Decades of research have proven that funds with higher fees earn lower returns over time.
Second Higher returns are Temporary !!! It can change anytime.. But the Higher fee always used to stay , even if the funds performance is beaten consistently.

Though everyone is aware that "The most powerful force in the universe is compound interest."
A small change in funds fee will have a significant effect on your returns.

Can we put a simple math Based on this??
If we consider that 1 Crore Invested in two funds which have similar performance have given 12% appreciation compounded annually with the following different fee structures.

1. High fee fund - 12% CAGR with 2.5 % Expense Ratio for 25 Years = 9.67Cr
2. Low fee fund - 12% CAGR with 1.5 % Expense Ratio for 25 Years = 12.14Cr

This means that somone have given 2.5 Cr for managing his money more efficiently for the same
growth!!! :) Ridiculous right..

2. The managers have biggest shareholdings in that fund.

Make sure that the fund Manager who manages your money have their large part of thier holdings put into the fund. Most of the firms even forbid their employees from owning anything but their own funds. These funds will manage the money as if like thier own money!!!

3. They dare to be different!!!

One of the all times great Investor Peter Lynch, was given the Magellan fund for Management. Magellan fund bought whatever seemed to cheap , Regardless of what other fund . Ones the funds Top Holding was on Chrysler an auto company, where most of the Experts thought that the auto maker to go bankrupt. So do check the holdings of the fund,Whether they
hold same as of all the funds.

Do see that they are aligned with the funds Principle. An equity diversified fund holding 35 % in technology and 30% in finance and only a small part in other sectors is not an diversified fund,In this simply fund manager is taking the risk rather than to be different.

4. They do shut their doors!!!

The best funds more often close to new investors, only allowing their existing shareholders to buy more. That stops the new buyers who want to invest which protects the fund from the pains of asset elephantiasis. It’s also a signal that the fund managers are not putting their own wallets ahead of yours. But the closing should occur before—not after—the fund explodes in size.
So do take care of these!!! This can make you sure that whether MF's are just intrested in their
Business and money or do they care for Investors Money.

So What else should you watch for? Most of us look at

1. Past performance first
2. The Manager’s reputation
3. Riskiness of the fund( Sectoral Remeber .Com crash)
4. Finally at the fund’s expenses.(This too No one giving Importance)

The intelligent investor looks at those same things—but in the opposite
order.

1. Fund’s expenses

Since a fund’s expenses are far more predictable than its future risk or return, you should make them your first filter. There’s no good reason ever to pay more than these levels of annual operating expenses, by fund category.

Diversified Indian equity Equites - 2 %
Index funds - 1 %

2. Riskiness of the fund

The Next filter factor is, evaluate risk.Try to get the prospectus of the fund,You can use value research online which shows a bar graph displaying its worst loss over a calendar quarter. If you can’t stand losing at least that much money in Four or Five months this is not the place for you. It’s also worth checking a fund’s value research online rating. A leading investment research firm, value research online awards “star ratings” to funds, based on how much risk they took to earn their returns (one star is the worst, five is the best). But, just like past performance itself,these ratings look back in time; they tell you which funds were the best, not which are going to be. Five-star funds, in fact, have a bad habit of going on to underperform one-star funds. So first find a low-cost fund whose managers are major shareholders, dare to be different, don’t hype their returns, and have shown a willingness to shut down before they get too big for their britches. Then, and only then, consult their value reseach or Money control rating.

3. The Manager’s reputation

Managers reputation is one of the factor in choosing a fund ,but if you choose a fund because of only his repuataion yet again be carful,Your taking a risk.Because there is always a fair 70 - 80% chance that he will move out to other investment firms.

4. Past performance

This is the least important thing one should look into.Just try to get a good fund.
Don't chase the 5 star rated funds and the top funds of the previous years.
But this should not be reason for you choosing a bad performer, or an yestrdays losers.
Because yestaredays loser never become tomorrows winner.So avoid someone who is having a consistent poor past records.