At a time when global headwinds and weak investor sentiment are leading domestic stock markets into a downward spiral, mutual funds have emerged as the first choice of investment for small investors. An increasing number of retail investors are traversing the Systematic Investment Plan (SIP) and Systematic Transfer Plan (STP) route to build a strengthened investment portfolio. The Indian Mutual Fund industry has witnessed an exponential five-fold increase in Assets under Management (AUMs) from Rs 4.17 lakh crore as on March 31, 2009 to Rs 23.80 lakh crore as on March, 2019. The Association of Mutual Funds in India (Amfi) further led credence to the fact that AuMs were pegged at a staggering Rs. 24.53 lakh crore in end-July 2019. The growth trend also reflects in the net accretion in MF folios which have seen a steady increase over a period of time. This effectively means that an increasing number of investors with a long-term mature investment outlook are staying put with MFs.
Investing in MFs allows the risk-averse investor to leverage the benefit of diversification. In other words, distribution of funds across varied asset classes like bonds, gold and precious metals enables an investor to minimize risk exposure in periods of market crises. Going for a diversified MF investment strategy allows for overriding of market volatilities and enables protecting the asset value of investments. Every asset category, from the most aggressive to the safest, has a different risk and return tendency. The aim here should be to minimize risks and maximize returns in the best possible manner. Optimal asset allocation forms a core part of diversification and facilitates distribution of risks across diverse investment classes. While going for asset allocation, an investor needs to take into consideration his risk profile and investment goals. An evenly distributed MF asset base also guarantees assured returns on a consistent basis in the short to medium investment tenure.
Several small investors are realizing the biggest advantage accrued from MF investments which is rupee cost averaging. When the investor invests in different funds using the SIP route, the fund manager purchases units at different net asset values (NAV). The NAV is directly proportional to the growth trajectory of the market. For instance, if market conditions are bullish, the NAV will be higher leading to the purchase of lesser units. When the market displays a bearish undertone, the NAV will be lower, leading to the purchase of more units. Seen from a long-term investment perspective, this helps in reducing the average purchase price of the investment, a core component of rupee cost averaging. Protecting the small investor from the perils of timing the markets, investing in MFs through SIPs helps in averaging out market uncertainties and enables the attainment of long-term investment objectives. MF investment also imbibes financial discipline in investors and inculcates the habit of investing in a systematic manner.
MFs work on the fundamental principle of compounding which helps in long-term wealth creation. To state simply, compounding is a long-term strategy and offers the benefit of multiplier impact by earning interest on the principal and re-invested returns. This ensures that investor wealth grows at a stupendous rate over a longer period of time, a benefit not offered by other short-term instruments.
As compared to other market instruments, MFs offer better economies of scale, enhanced liquidity and better risk management. Having said this, mutual fund penetration in India remains dismally low inspite of record inflows across various fund categories. The pan India penetration of MF remains a paltry 5 per cent, which presents a huge opportunity for the MF industry to expand scale and achieve market outreach.
The author is the Head Mutual Funds & TPD at LKP Securities