Understand MFs To Get Desired Results

In the changing financial landscape, mutual funds are playing an increasingly important role in the investors’ portfolio. While mutual funds offer a lot in terms of variety, flexibility, transparency and tax efficiency, it is crucial for investors to have a clear understanding of the products. It is equally important to have them in the portfolio in right proportion in line with one’s risk profile and time horizon.  However, understanding products at time can be a little tricky. Though it is easier to differentiate between products like a diversified fund and a specialty or a sector fund, it can be challenging for investors to differentiate between products that may have similar features and characteristics. However, the key is to understand that in spite of having a few similarities, the end results could be substantially different.  A couple of such examples are diversified equity fund vs. multi/flexi-cap fund as well as Index funds vs. Exchange Traded Funds (ETF). Let us analyze how are they different, and the pros and cons of investing in them.

Diversified Funds vs. Multi-cap/Flexi-cap Funds
A diversified fund is a fund that contains a wide array of securities. The fund manager of a diversified fund actively maintains a high level of diversification in its holdings, thereby reducing the amount of risk in the fund. In a typical diversified fund, the offer document provides freedom to the fund manager to invest across industries as well as various market segments, i.e. large-cap, mid-cap and small-cap. However, most fund houses have internal guidelines for fund mangers with regard to the maximum exposure they can have in each industry as well as segment. As regards flexi-cap/ multi-cap funds, though broadly speaking, they belong to the category of diversified funds; the offer document clearly spells out the limits for minimum and maximum exposure to different market caps. To that extent, an investor retains the control on the exposure to each market segment, which is not possible in a typical diversified fund. At the same time, thanks to the flexibility available to the fund manager in a diversified fund, he may be able to handle the volatility in a much better manner.

Index fund vs. ETF
An index fund is a type of passively managed fund that seeks to track the performance of a benchmark market index like BSE Sensex or S&P CNX Nifty. To achieve this intended result, the fund maintains the portfolio of all the securities in the same proportion as in the benchmark index. The offer document of an index fund clearly states as to which index the fund would track. The major advantage of investing in an index fund is that one knows exactly the shares the fund would invest in. Besides, for an individual investor, it is practically impossible[PAGE BREAK]

to create a portfolio that matches an index fund portfolio. The downside of investing in an index fund is that one forfeits the possibilities of earning above average returns that a good quality diversified fund may be able to provide over the longer term. An Exchange Traded Fund (ETF) is a hybrid product that combines the features of an index fund as well as stocks. These funds are listed on the stock exchanges and their prices are linked to the underlying index. ETF can be bought and sold like any other stock on an exchange. In other words, ETF can be bought or sold any time during the market hours at prices that are expected to be closer to the NAV at the end of the day. Therefore, one can invest at real time prices as against the end of the day prices as is the case in open-ended schemes. The most common ETFs in India track an index. These ETFs do not stick to the basic Sensex and Nifty, but offer more options to investors. Nifty Bees, Junior Bees, Gold Bees, Bank Bees and Hang Sang Bees are some of the ETFs traded in India. Gold ETFs have a significant presence and are actively traded in India. One of the recent additions has been the Shariah-based ETF launched by Benchmark Asset Management Company, which intends tracking the Nifty Shariah Index.