Any investor with a long-term investment plan for retirement cannot give equities a miss. And any investor who plans to invest in equities cannot give mutual funds a miss. That is why mutual funds have a critical role to play in your retirement planning portfolio.
Mutual funds and retirement planning have enough points in common to make them perfect for each other. Consider this -- retirement planning is about investing for the long- term, at times for even longer than 35 years.
Mutual funds (equity-oriented funds to be more precise) are also about investing for the long-term. This is because equities as an asset class are best equipped to 'deliver' results over the long-term. Over the short-term they can be extremely volatile and may even erode your retirement savings.
There is little doubt that equity funds can help you achieve your investment goals. But for that to happen, you need to be invested for the long-term; at least 10 years in our view from a retirement planning perspective.
If you are saving for retirement by taking the equities route you will need advice; and we mean advice from experts and not tipsters, brokers, television channels or magazines for most of whom long-term means the next hour, next day or next week.
When you have money in equities you need someone to constantly monitor the stock markets, the economy, interest rates and various domestic and global factors that are likely to have an impact on your investments.
Given the enormity of the task it is easy to appreciate why managing equities is a full-time job. This is where mutual funds come in. Mutual funds usually have investment teams that seek investment opportunities in the stock markets on a full-time basis.
This is something that as an investor you may attempt to do on your own, but may never have enough time or capability for given your personal and work commitments.
Having highlighted the benefits of long-term investing in equities, we would like to draw your attention to another critical aspect of retirement planning, i.e. asset allocation.
Asset allocation is very important when you are deciding on your retirement portfolio. We have seen instances where stock market slumps have lasted for over 20 years. During that period, investors with above-average allocation to stocks witnessed significant erosion in their portfolios.
On the other hand, investors who had diversified their assets across avenues like bonds, gold, property and cash, managed to stay afloat and in some cases even clock reasonable returns. That is what asset allocation is all about; it allows investors to benefit from a well-diversified portfolio that helps them exploit opportunities and cut losses across ups and downs in the various asset markets.
Despite the relatively smaller domestic mutual fund industry, you can be sure that selecting the best mutual fund schemes for retirement is a challenge.
There are several reasons for that -- for one the industry has too many schemes within each category with little separating one from the other. And second, there are too many unscrupulous agents trying to milk their commissions out of unsuspecting investors by talking about the most irrelevant, but high commission paying, schemes. The irrelevance is even starker, when you consider the schemes from a retirement perspective.
So what is the best way to identify the mutual funds that must find their way to your portfolio? To be sure, there are ways to spot the right mutual funds; and the good news is that with a little bit of homework and some help from your qualified investment advisor you can be as good as anyone else at it.
1. Systems
Pick up any business daily today and the one headline that is likely to hit you is about a fund manager leaving an AMC (Asset Management Company). If you are invested in that mutual fund then the first question that will come to your mind is -- what should I do now?
You are not alone; we get a barrage of emails and calls from investors when a star fund manager leaves his job to join the next mutual fund, or these days, a hedge fund.
In some cases, it's downright unfair to the investor when he invests in a 'new fund offer' (NFO) because of a star fund manager, only to find the news of his departure being leaked once the NFO period is over.
Our advice to you -- don't get married to your fund manager. Instead pick an AMC based on its investment processes and systems and not its star fund manager.
Process-driven AMCs adopt a team approach (as opposed to an individualistic approach), which tends to de-risk the exit of an individual leaving the team. When you are selecting a mutual fund make sure that it has well-defined investment processes that can function well even in the absence of a particular fund manager. We do not expect investors to have access to this information as easily as we make it out to be; that is where your investment advisor/mutual fund agent comes in.
Ask him about the processes and systems adopted by various AMCs. If his advice is based on solid research and not commissions then he should be able to answer a lot of your questions on this topic.
2. Track record
Once you have identified an AMC with well-defined investment processes, you should check its track record. Typically, equity fund performances must be monitored over at least three years in our view and from a retirement viewpoint, over 10 years.
Some times you have a relatively new AMC like Fidelity Fund Management for instance, (with an established track record in other markets) that can't be gauged on the minimum 3-year track record. In such a scenario it makes sense to dig a little deeper and find out what its achieved in other markets, its systems and processes and what kind of experience they have in managing domestic stocks.
Even for mutual funds with longer track records, it is important to consider how it fared during a market downturn, which is what separates a good fund from an average one.
Once you have identified an AMC for its team-based investment approach, look for some signs that show its approach works. The most obvious place to verify this is in the performance. An AMC with systems in place is likely to have its funds perform in a typical manner.
For instance, if an AMC has a process that ensures its equity funds are very well-diversified in terms of stocks and sectors, then these funds will counter a market downturn much better than their concentrated peers.
Also over a period of time, there will be a degree of consistency in the performance of the AMC's equity funds. While evaluating an AMC's equity schemes it is important to consider the volatility and risk-return parameters.
Well-managed equity funds tend to have lower volatility which is reflected in lower Standard Deviation numbers over time. Likewise, they have higher risk-adjusted returns, which is reflected by higher Sharpe Ratios.
3. Go for funds with well-established track records; avoid NFOs
When you look at the domestic mutual fund landscape you see too many funds that have little relevance from a retirement planning viewpoint. A lot of them are thematic funds that, to begin with, do not have much of a track record.
Moreover, when you are planning for retirement over a 20-30 year period, it is best to ignore themes and go for funds that invest across stocks and sectors without any bias. We believe that over the long-term, thematic fund performances are likely to be more erratic than consistent.
There will come a time when the theme will have run its course leaving the fund manager with a truncated list of investment options. That is why it is best to invest in an equity fund that targets 'capital appreciation' -- plain and simple, and not 'capital appreciation through opportunities in outsourcing/capital goods/infrastructure/consumerism.'
Remember if theses themes really merit investment then even the conventional equity fund manager is likely to invest in them. But the advantage he has is that he can exit the theme once it loses steam, unlike the thematic fund manager who has to remain invested in adherence to his investment mandate.
Another thing to avoid is NFOs, not that we have anything against them, but a lot of NFOs that are being launched presently are of the thematic fund variety. If there is an NFO of the 'conventional' variety, then we would recommend you evaluate it on the first two parameters.
Our preferred AMCs
Having researched mutual funds for more than eight years, our mutual fund research team has grown to prefer some AMCs over others. Their performance, track record and processes are the main attributes that caught our eye. Of course, that is not to say that others do not have them; it's just that we have short-listed the three that we like the most.
1. HDFC Asset Management Company
HDFC Asset Management Company is a joint venture between HDFC (50.1% stake in HDFC AMC) and Standard Life Investments of UK (49.9%). It was launched in September 2000. While its performance took a while to kick off, there was no mistaking its well-defined investment processes and systems.
Today, it has some of the better performing funds across the diversified equity, tax-saving, balanced and monthly income plan (MIP) segments. Contrary to popular perception, its best funds are a mix of the erstwhile Zurich India Mutual Fund (which it took over in 2003) as also funds launched by it since 2000.
The fund's team-based investment approach is apparent from the fact that even with a star fund manager like Prashant Jain in its midst, there are several other equity fund managers managing various funds that compare well with their peers.
2. Franklin Templeton Investments
Launched in 1996, Franklin Templeton Investments is among the more well-established names in the mutual fund business. It acquired Pioneer ITI in 2002 and became one of the leading fund houses in the country with some of the best equity funds and an experienced and proficient equity fund management team.
The fund house pursues a team-based, process-driven investment approach, something that came to their rescue when their Chief Investment Officer -- Debt quit last year.
3. Sundaram Asset Management Company
Sundaram Asset Management Company is among the more conservatively run AMCs in the country. A pointer to this fact is that its funds rarely feature in the rankings; it is equally true that they rarely disappoint investors. As a matter of fact, over the years investors have come to expect a certain degree of consistency and stability in their performance.
Like with the other AMCs we like, Sundaram Mutual Fund has a team-based system in place. Recently BNP Paribas acquired 49.9% stake in Sundaram Asset Management Company, thereby bringing down the Sundaram Group stake to 50.1%.
Our interaction with the AMC indicates that this is unlikely to have an impact on the fund management style of Sundaram Mutual Fund's schemes.
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