Your mutual fund misconception demystified

Here's what you should look at before investing in mutual funds.

A reader sent in an observation regarding two funds: Reliance Growth and Franklin India Prima. According to him, he invested in both when the net asset value, or NAV, of each were in the same range.

Much to his amazement, the NAV of Growth shot ahead, while Prima could not keep up. He concluded that his investment in Prima has let him down.

Has it?

They might have shared common ground at one time, but each has its own distinct character.

He is right on one count though. Early 2005, the NAVs of both funds were very similar. In fact, on January 19 that year, the difference was just Re 1: Growth at Rs 105 and Prima at Rs 104. Since then, Growth galloped ahead.

As on April 25, 2016, Growth was at Rs 761 while Prima was at Rs 672.

However, the interpretation that Prima has not delivered is wrong.

Such misconceptions stem from the wrong perception of NAV. Investors tend to view it the same way as a stock's price and hence give it much more attention than necessary.

Giving undue importance to the NAV is the same reason why investors flock to NFOs assuming that they are getting a bargain at Rs 10 per unit despite the fact that there are ample funds already in existence with excellent track records and identical investment mandates.

The logical way to decipher whether or not a fund works for you is to see how it blends in with the rest of your portfolio, its expense ratio, whether you are at home with the manager's style, and the fund's annualised returns over a significant time frame.

The absolute value of the NAV should not make a difference. For instance, if we look at the point-to-point returns of the two funds from January 19, 2005 (when their NAVs were virtually identical) to April 25, 2016, Growth has delivered 19 per cent and Prima, 18 per cent. And if you look at the annualised returns over certain time periods, Prima has actually beaten Growth (see table below). This proves that relying solely on the quantum of NAV is wrong.

If we look at the data over a decade, we see that Growth performed excellently when compared to Prima (see table below). From 2009 onwards, the fortunes were reversed resulting in the impressive annualised returns of Prima.

While we set out to show that the reader's perception is wrong, we are not saying one fund is better than the other.

Growth fund manager Sunil Singhania is an excellent stock picker. Between 2005 and 2007, despite a furious bull run, he held onto a large-cap allocation and did not plunge headlong into smaller fare. Despite that, he performed tremendously well, a testimony to his stock picking skills.

During the above mentioned period, Prima did not perform as well as Growth despite being true to its mandate of being a mid- and small-cap fund.

In fact, its allocation to mid- and small-cap stocks led it to fall harder than Growth in the 2008 downturn. Since then Prima has kept some exposure to large caps but remained a true mid- and small-cap fund.

Over the years, as the fund size of Growth bloated, Singhania ensured a substantial allocation to large caps. It is for this reason that the fund now falls under our flexi-cap categorisation of funds.

On a closing note, if you are interested in investing in any of the above funds, make note that they fall under separate categories. One is a mid- and small-cap fund, the other a flexi-cap. So pitching one against the other is not a relevant or fair comparison. Look at each within their respective categories. And, don't get swayed by absolute NAVs.

References to the returns and NAV are for the growth options of regular schemes.

Illustration: Uttam Ghosh/Rediff.com