Alhough much-maligned for their non-performance, mutual funds continue to be the best-bet for investors. While a multitude of funds exist in the market, the choice of the fund depends on the investor's needs and appetite for risk. Different funds are suited to achieve varying financial goals for investors with uneven appetite for risk.

The cost of acquiring financial assets could be much steeper than most people would imagine. And disciplined saving is the most important requirement for building financial assets. Of course, the road to financial security will be much smoother if an investor gets the highest possible return on his savings. Thus, to maximise returns, one has to wisely split his moolah among various assets like equity and bond funds since no single investment can provide complete financial security.

Equities, which deliver high long-term returns are unpredictable in the short-term. Bonds provide a regular and reliable stream of income but the real returns could be severely hit with a rise in inflation. Though investments in bank deposits and money market funds protect investors from market losses, their mediocre yields barely match with rising prices. However, in case of a diversified portfolio, the strength of one asset class offsets the weakness of another, thus providing both high returns and reasonable safety.

Another crucial aspect that has to be looked into is the risk-tolerance, which depends on time. If an investor plans to withdraw money within a few years, a sour market like today's can hurt him more than inflation. But if the money is not required for a decade or so, one faces a higher degree of risk from even a modest rise in inflation. So, if requirements are in the immediate future, one should favour safer investments such as bond funds and bank deposits. On the other hand, if the time permits fund deployment for several years, the investor should lean towards riskier and high-return equity funds.

Long-term growth with equity fund

We take a look at three kind of funds available today to achieve your financial goals. Growth funds aim at capital growth by primarily investing in equity instruments. On an average, growth funds invest at least 80 per cent of their corpus in equities. While these funds earn profits through investment in stocks, their approach can be different. They could be classified as conservative growth, `value' funds, aggressive growth funds and small cap and IPO funds. The classification is not air tight, with funds following more than one strategy at times. Still, most funds are guided by a particular strategy.

The conservative growth funds primarily invest in blue chip companies, including large cap index stocks and PSUs. Most of the UTI growth funds including Mastergain '92, UGS200, UGS5000, US '92, Mastershare and the recently launched Index Fund fall into this category. ITC Threadneedle Top 200 is also a conservative growth fund. The companies most widely held by these funds are household names. These funds are the first to appreciate in a market turnaround but lag behind in a sustained bull phase. Over an extended period, these funds are likely to trace the major market indexes.

The `value' funds primarily adopt a strategy of buying bargains where ever they exit. Bargains here mean shares, which for a variety of reasons, are selling at a price which is lower than its intrinsic value. These funds invest in companies with low price-to-earning ratio, low price-to-book value ratio and high dividends-yield. The Templeton India Growth Fund and Sun F&C Value Fund fall in this category. These funds may not appreciate for an extended period of time and short to medium term investments should be avoided.

The aggressive growth funds primarily aim at investment in companies with outstanding future growth prospects. The funds' portfolio generally comprise of small and mid-cap stocks which have the potential of emerging as blue chips over an extended period of time. Birla Advantage and Morgan Stanley, JM Equity (G) are examples of such funds. Generally in a bear phase, the fall in these funds is sharper than the overall market but these funds tend to rise faster than the market in a sustained rally. These funds are suited for investors who have the time and patience to wait for a big payoff.

Small cap and IPO funds have the highest risk but they also are the most rewarding. These funds primarily invest in smaller, less mature companies, and often invest in initial public offering. In these funds, period of superior returns can be followed by slumps. The success and failure of Bluechip and Kothari Prima demonstrate this. Other funds in this category include Starshare, Prima Plus, Newshare, PEF etc.

Besides, there are sectoral funds which primarily invest in a specific sector. The idea is to ride a sector which is expected to grow at a faster rate than the economy. Specialised funds like JM Basic do have a narrow investment focus and the investors have to remember that specialised funds are likely to be high risk investments. The predominant influence on most equity funds, of course, is the rise and fall in the market. When the fund diverges sharply from the market performance, the difference can usually be explained by the fund's investment strategy. Essentially, it depends on the fund being in the right segment of the market at the right time. The fund should ultimately suit an investor's risk-return profile. The other important factor for investment in equity funds could be a high dividend yield and the high discount to NAV. Funds like Mastersahre and JM Equity (D) have been regularly making payouts and these are unlikely to be discontinued unless the funds start incurring losses.

Many listed closed-end funds seem to be good bargains. Trading at handsome discounts ranging between 30-50 per cent, they are just too good to resist. Some of these could well turn out to be rare gems, but one has to steer clear of many hazards through careful filtering. The discount on Masterplus, Magnum Multiplier '90 and Mastergrowth particularly looks tempting.

Steady yields with bond funds

Income funds offer diversification primarily through investments in debt. There are various income funds available like monthly income, quarterly income, six monthly income, yearly income and cumulative income. While investors could opt for one of the regular income paying funds to meet their requirements, income funds offering cumulation of income are perhaps the only instruments which convert interest income into capital gains and hold special appeal to investors in the high income bracket. With most funds promising returns, income is more or less assured. The UTI MIP series could be good cumulative income vehicle with its assured return. Open-end income funds offer another benefit of converting illiquid debt into liquid investments.

Mixed breed

Balanced funds are of a special appeal to conservative investors for steady long-term returns seeking equity exposure with low volatility. While these funds do not fall as sharply as a pure growth scheme in a bear market, they also do not rise as sharply as a growth scheme in a bull market. A balanced portfolio has two goals, viz., income and moderate capital appreciation. Balanced funds are especially appropriate for individuals who can afford only one fund, since they are diversified into the both bond and stock markets. They also make sense for beginners who want some returns with reasonable conservative orientation.

Tax effective retirement planning

In 1992, the Union Government decided that middle class investors should be encouraged to participate in the equity market. Accordingly, it announced the Equity Linked Saving Scheme 1992. Under this scheme, investments of Rs 500 and above and in multiples thereof, but with a maximum limit of Rs 10,000 made by individuals and HUFs, are entitled for a tax rebate at 20 per cent of the investments made.

In other words, if an investor deploys Rs 10,000 in ELSS and his tax liability is Rs 4,000, 20 per cent of Rs 10,000 or Rs 2,000, would be reduced from his tax liability. This will bring down the tax liability to Rs 2,000. This investment would be locked in for a period of three years. Thus it cannot be sold or pledged. After three years, however, it can be redeemed or sold in the stock market.

The best strategy to adopt in a tax saving fund is to hold on to the investment as long as possible. This is because in a tax saving fund, on redemption, 20 per cent of the face value is deducted at source. The investor would be giving away Rs 2 per unit to the tax man which would otherwise be working for him till redemption.

Currently, pension schemes offer benefits under section 88 of the Income Tax Act. Subscription made out of income chargeable to tax by an individual in Pension Plan, up to an amount not exceeding Rs 60,000, will qualify for deduction from income tax at 20 per cent of the subscription. Though pension schemes offer tax incentives, another method of saving for retirement could be the systematic investment plans of an open end scheme. For instance, while saving for pension, an investor in 25-30 age group could go in for a systematic investment plan of an open-end growth fund. As he approaches his retirement, he could shift to an open-end debt fund and ultimately on reaching retirement, go in for a systematic withdrawal. This could be a better strategy than investing in pension schemes, whose asset allocation would remain unchanged despite the changing risk-return profile of the investor.

Copyright © 1997 Indian Express Newspapers (Bombay) Ltd.