The mutual fund is, finally, proving its metier as a vehicle of safety. But it is still the fund-manager's investment philosophy that makes the difference between the winners and the losers. Specialised schemes offer impressive returns.

By Roshni Jayakar

The smiles are mutual. One set of market-players heaving a sigh of relief is the mutual funds industry: asset-management companies and fund managers. Over the past year, the mutual funds have caught the fancy of the Indian investor who is, increasingly, opting for this avenue to channel his investments into. In developed markets, individuals rarely invest directly in stocks. Instead, they opt for mutual funds. Contrarily, in India, investors have shunned the mutual funds. And with good reason. In recent years, the Net Asset Value (NAV) of many a mutual fund has plunged below its face-value, cutting into even the principal invested. Part of the problem is that investors perceive the mutual funds to be closer to speculative stocks-with money to be made in quick trades-than to their real selves. That, unfortunately, is a flawed perception.

Mutual funds invest money in a basket of securities-a mix that rarely behaves like a single stock. And never like a high-adrenaline speculative stock. Yet, there are funds that have bucked this trend. In the past 2 years, quite a few mutual funds have rewarded investors with handsome returns. The good news is that this is poised to become a trend.

Thanks, in part, to Union Finance Minister Yashwant Sinha's UB 99, which has made income from mutual funds tax-free. Pre-budget, only incomes upto a ceiling of Rs 15,000 per annum enjoyed this exemption. Now, dividends from open-ended equity funds, including the State-owned Unit Trust of India's massive us-64, has been spared from the tax for 3 years.

Of course, in the case of funds investing less than 50 per cent in equities, a 10 per cent dividend tax will apply. But there is also the twin advantage of a cut in long-term capital gains tax: from 20 to 10 per cent. The two together offer a reasonable rationale for investing in the mutuals. Advises veteran fund manager K.N. Atmaramani, 58, Managing Director, Tata Mutual Fund: ''With a better track-record, with returns becoming tax-free, and with the stockmarkets turning bullish, the mutual funds will enable you to diversify your risk wisely.''

There's more. The mutual funds have strengthened their distribution networks, become more transparent and investor-friendly, and are rewarding investors. So, how do you go about choosing a mutual fund? First, ask yourself some simple questions: how long do you want to keep your money invested? What is your tolerance to risk? If you aren't in a hurry, and if you don't mind taking some risks, you may want to consider the stock (or growth) funds that invest in equities.

On the other hand, if you need the money soon-for big-spend events like, say, buying a house, or your children's education abroad-you may want to go in for the more predictable fixed income (or bond) funds that mainly invest in fixed-return instruments. Of course, to get the best of both worlds, you should opt for a mix: put part of your money in the riskier growth funds, and hedge it with the other in income funds. Or, choose a balanced fund, which does just that.

However, says Abhai Aima, 37, Vice-President, HDFC Bank:''Allocations to mutual funds will vary depending on the individual's profile, his appetite for risk, and the time-horizon for investment.'' The tougher decision is in choosing the funds of each type. Your best bet is to go in for winners with a good track-record, but don't bank on past performance alone because yesterday's results are no guarantee for tomorrow's performance. The fund whose units you just bought because it had performed so well last year may turn out to be a lemon this year.

What, then, is the solution? You have to judge the quality and the strategies of the asset-manager running the fund. The track-record is one part, but many fund-managers think there is more to it than that. Believes Ajay Srinivasan, 34, CEO, ICICI-Prudential Asset Management: ''Philosophy, and the style of fund-management are crucial in making a choice.'' Just as you would judge the quality of management at a company, you have to look closely at the fund-manager. Is his management style institutionalised? Or is it the personal style of a whizkid? If the latter is true, there could be trouble. What happens if he moves on?

Let us talk about more mundane choices. If you are an aggressive risk-taker, put more of your money in open-ended equity funds. Choose a fund that offers a dividend option. Some equity funds are now planning to offer dividend reinvestment options to make them more attractive. Go for them. Quite a few growth-oriented equity funds have built up impressive track-records, out-performing the benchmarks by a wide margin.

Last year, while the stockmarket remained flat, stars like the Birla Advantage Fund posted returns of 58.56 per cent for the first quarter of 1999, and 123.50 per cent for 1998; Sun F&C Value Fund managed 56.37 and 86.65 per cent; and Kothari Pioneer Prima touched 47.07 and 83.11 per cent, respectively. Since April 1, 1999, almost all the equity funds have introduced an entry load, which is a sales charge varying between 1.50 and 2 per cent above their NAVs.

However, given the fact that most equity growth funds yielded returns of 40 per cent and above in the first quarter of 1998, and nearly 100 per cent for the whole year, a load of 1.50 per cent is a pittance. In debt funds, the yields are just 12 per cent, though, a charge of even 0.50 per cent makes a big difference.

The most straightforward income funds are the money market funds, which invest mainly in short-term T-Bills and the call money market. They are, usually, used to park cash for emergency use. Now, these funds offer a cheque-book facility, and are a better option vis-à-vis bank deposits. If you are risk-averse, or have become disgruntled with the stockmarket-there has been enough reason for that in the recent past-go for the bond fund alternative.

Do you have surplus cash lying around in your personal account? If you aren't really looking for a regular income, why not invest in bond funds? With interest rates declining and heightened credit-risk worries, bond funds can let you protect capital after inflation. Opt for open-ended growth bond schemes-instead of dividend schemes-because their post-tax yields are higher. Explains Dhirendra Kumar, 30, CEO, Value Research, which tracks mutual funds for BT: ''Dividend tax is a dampener for closed- and open-ended schemes since their NAVs will fall by 10 per cent of their dividend payout.'' So, investors, advises Kumar, should shift from dividend plans to growth plans, which offer considerable scope for tax-planning.

While there are no fixed rates of return, the yields on these units broadly reflect the interest rates prevailing in the market. You could expect a rate of return of 12 per cent over the next year. Also, investments in the growth plans of open-ended bond funds qualify as long-term capital assets if held for more than 1 year. The benefits: a lower tax-rate of 10 per cent on long-term capital gains, and an inflation indexation of your purchase price, which reduces taxable gains.

Be careful, though. Warns Shekhar Sathe, 48, CEO, Kotak Mahindra AMC: ''It will be wrong to believe that fixed income funds are safe because there is still room for credit- and interest-risk.'' Funds may invest in bond issues that default and, therefore, jeopardise your investments. But some funds have protection against that. Kotak Mahindra Asset Management's K-Gilt Scheme has reduced its credit-risk by investing in fully-secured government paper. And ICICI-Prudential AMC is launching a fund for investment in GILTs.

Bond funds? Or equity funds? Fixed return? Or growth? Confused? Don't worry, there's help at hand. If you want to play it safe, go for the balanced funds. They protect you from the downside risks of the stockmarket by putting 30-50 per cent of their assets in fixed-return instruments and the rest in equities. Funds that invest more than 50 per cent in equities-like pure equity funds-enjoy dividend tax-exemptions.

Balanced funds are a good option if you have a middle-of-the-road risk-profile. Some of them have turned in exceptional returns-like Alliance 95 (dividend), which yielded returns of 43.03 per cent in the first quarter of 1999 and 84.70 per cent in the last 1 year; Magnum Open-End, 37.73 and 38.64 per cent, and Tata Young Citizens, 13.34 and 32.08 per cent in 3 months and 1 year, respectively.

Balanced funds are tame stuff for the dare-devil, inveterate risk-taker. If you are one, opt for sector-specific funds. They are appropriate for adding aggressive incremental diversification, and a quick way of participating in a particular industry without choosing individual stocks. They are focused sector funds that invest in the stocks of a single industry, and have high growth potential.

While it is, indeed, like putting all your eggs in one basket, some of these funds will tempt you with their heady returns: Kothari Pioneer Infotech Fund's NAV doubled in just 4 months. But from its peak NAV of Rs 21.76 on March 31, 1999, it dropped to Rs 16.80 on April 27, 1999-a fall of 22 per cent. Other sector funds include ICICI-Prudential's FMCG and pharmaceuticals funds. In all, there are 5 sector funds focusing on the 3 hot sectors: infotech, pharmaceuticals, and FMCG. Points out Value Research's Kumar: ''While stocks in these sectors are market-leaders, larger cyclical stocks have enjoyed such periods of superior performance at one point or another.''

Focused funds give better returns than those which invest in a mixed bag. Dundee Mutual Funds has a real estate fund and a gold fund. Now, ITC Threadneedle AMC is launching an M&A fund, which will target stocks of companies where there could be asset plays. But they aren't for the faint-hearted. They are the closest you can come to investing directly in stocks since you have to monitor the sector carefully. If you aren't a stockmarket wizard, take some advice from Simon Holdsworth, 35, Managing Director, ITC Threadneedle AMC: ''Typically, an investor should put in 5-10 per cent of his investment in special funds while the larger portion should go to broad-based equity schemes.''

The rule-of-thumb is that broadly-diversified funds should form the core of your portfolio, with more specialised funds providing enhanced returns. Focused funds are risky, and you have to keep an eye on the sectors you are betting on. If you think that that is a tough proposition, there is an alternative. Some funds offer you the opportunity to ride growth sectors and, yet, are not too risky. Tata Mutual Fund is planning a 5-sector life sciences and technology fund that will invest in pharmaceuticals, agrochemicals, FMCG, telecom, and infotech stocks. Says Tata Mutual Fund's Atmaramani: ''We will have the flexibility to shift to any of the 5 sectors so that this can be a long-term investment option.''

With the post-Budget stockmarket boom, the NAVs of many funds have shot up. So, should you wait for the market to settle down before you invest in them? Probably not. Suggests Kotak Mahindra AMC's Sathe: ''Take a long-term view, and select a fund with a portfolio that promises continuous growth.'' For timing the market, you need 2 accurate predictions: knowing the right time to buy-and sell. Miss either, and you will miss the market.

Most of the market's gains occur in just a few strong, but unpredictable trading days here and there. To tap the market's long-term performance, you have to be in the market on all those days.What makes a fund perform well? Its portfolio, naturally. Growth funds that have turned in good results-Birla Advantage, Zurich India, JM Equity, Magnum Multiplier Plus, and Blue-Chip-have a high percentage of their portfolio invested in the 3 sectors: pharmaceuticals, infotech, and FMCG. You could also benchmark the performance of the fund or its NAV against various indices, like the Bombay Stock Exchange (BSE) Sensitivity Index, the National Stock Exchange Nifty, or the BSE National Index, the BSE 200 for equity funds and the I-Sec Bond Index for bond funds.

Once you have selected a fund and put your money in it, don't think you can sit back and forget it. True, there are fund managers doing your job for you, but there is work for you too. Advises Vijay Venkatram, 33, Manager (Private Banking India), Hongkong & Shanghai Banking Corporation: ''The key to riding an investment opportunity lies in being able to select the right fund, and regularly monitor its performance.'' Once you have chosen the fund and made your investments, it is important to keep tabs on its performance to make sure that its performance continues to be in line with your investment objective.

How often should you review your investment? The thumb-rule is to do it if your investment goals change or the economic conditions alter. In any case, it is a good idea to review your portfolio at least once a year. Remember, though, that the performance of your fund has to be viewed against that of the stockmarket. Also, do not panic needlessly. Fluctuations in investment are a fact of life for stock and bond investors. After all, if prices do not move, what is the point in investing? How else will your fund-manager deliver the gains you're looking for?

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