Why good mutual funds lead to investor losses?

S&P BSE Sensex gave 14% returns (CAGR) over the last ten years (from 31^st Dec, 2003 to 31^st Dec, 2013) (Source: Ace MF) (Past performance may or may not sustain in future). However, there would be many investors who might have booked much lesser profits, or even losses from their investments, even though the S&P BSE Sensex performed well. How is this possible? When equities have delivered 14% returns, how have investors lost their money? Read on to find out.

Generally, it’s true that the returns retail investors earn from market investments tends to be lower than the returns from the market. This holds true not only in India where awareness of financial products is low but also in developed markets like the US.

Quantitative Analysis of Investor Behaviour (QAIB), a research study by DALBAR a US firm that has been undertaking this study for 19 years, notes in the report for 2013 that the results consistently show that the average mutual fund investor earns less - much less than the fund’s returns (source: www.dalbar.com).

The main culprit tends to be the investors themselves - and their tendency to incorrectly time markets. And unfortunately, more often than not, the average retail investor gets timing wrong. Historical trends seem to support this. Investors rush to invest in mutual funds when the markets are at a peak or are nearing one and avoiding them or even exiting them when markets are falling, fearing that they may lose more. This behaviour works detrimentally for their returns because logic teaches us that more units ought to be accumulated when they are available cheaper, i.e. when markets are low, and fewer when they are expensive, i.e. when markets at their peak.

Past performance may or may not sustain in future

Source: www.bseindia.com, www.amfiindia.com(Monthly factsheet); chart compiled by Quantum AMC

It is observed that in months following poor market performance mutual funds sales declined and they increased when markets performed better. Thus investors, knowing or unknowingly, led either by apprehension or overconfidence, tend to time markets and unfortunately mostly end up wrong.

The fact is we cannot accurately time markets every time and therefore perhaps an SIP is the best way for investors to accumulate funds for their goal. SIP automatically takes care of the investment logic that fewer units ought to be purchased when markets are up and more when they are down. This technique is popularly known in industry jargon as rupee cost averaging. To study trends in order to buy or sell assets at relatively best market prices is the job of the research team and fund managers – and it is best left to them.

However, there could be more practical answers to the dilemma why the returns, investors have actually earned are different, even though equities have performed well. Like you would appreciate, the return of mutual fund schemes changes daily as NAV changes daily. It could be possible that the markets have moved significantly from the date you checked performance or when the last factsheet was published. Usually the difference would not be too wide except possibly in times when markets are extremely volatile.

Another possible reason is that you could be comparing your returns with returns of the scheme for a different holding period. For example suppose you find that your mutual fund scheme has given 20% annual returns in 5 years, 5% in 3 years and 9% in 1 year; depending on what your holding period is your returns can vary. An investor who only happens to come across the 5 year return might wrongly expect that since the fund has given 20% returns in the last 5 years he/she might earn similar return for his/her investment of 3 years. It is incorrect to assume that if the scheme has given certain returns over a certain period then its returns in a different period (either longer or shorter) can be guessed closely, like in term deposit.

Moreover, exit loads and taxes which may be applicable, depending on your holding period, can also eat off some part of your returns. The effect of exit loads on returns is felt more in equity schemes whereas of taxes is felt more in debt schemes, when the holding period is shorter.

At the root of the problem is lack of adequate knowledge. Sadly, due to lack of knowledge, for a common man investments still remains ultra-complicated. Therefore, Quantum has always believed that educating investors can empower them to make rational investment decisions. Our newsletters Quantum Equity Direct, Golden Truth as well as our regular nationwide investor interaction event Path to Profit is aimed at achieving this.

With SEBI making investor education and awareness initiatives mandatory for mutual funds late in 2012, many AMCs have launched such initiatives. However ultimately the onus of understanding how your investments work is upon you, dear investor. This can keep your investments from falling prey to human tendencies. Always remember, be fearful when others are greedy and greedy when others are fearful.

Statutory Details and Risk Factors:
The views expressed here in this article are for general information and reading purpose only and do not constitute any guidelines and recommendations on any course of action to be followed by the reader. The views are not meant to serve as a professional guide / investment advice / intended to be an offer or solicitation for the purchase or sale of any financial product or instrument or mutual fund units for the reader. The article has been prepared on the basis of publicly available information, internally developed data and other sources believed to be reliable. Whilst no action has been solicited based upon the information provided herein, due care has been taken to ensure that the facts are accurate and views given are fair and reasonable as on date. Readers of this article should rely on information/data arising out of their own investigations and advised to seek independent professional advice and arrive at an informed decision before making any investments. Please visit – www.quantumamc.com/disclaimer to read scheme specific risk factors.