MF Investment Guide

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Amey Joshi Page 1 of 20 4/11/2008

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Index

GROUND RULES FOR INVESTING .....................................................................4

ALL ABOUT MUTUAL FUND INVESTING ...........................................................5

BENEFITS OF INVESTING IN MUTUAL FUNDS ...............................................6

AFFORDABLE .......................................................................................................6

PROFESSIONAL MANAGEMENT ........................................................................6

DIVERSIFICATION .................................................................................................6

LIQUIDITY ..............................................................................................................7

TAX BENEFITS ......................................................................................................7

BASICS OF MUTUAL FUNDS ...............................................................................7

GETTING STARTED .............................................................................................7

STOCKS ................................................................................................................7

BONDS ..................................................................................................................7

DIVERSIFICATION .................................................................................................8

Types of Mutual Funds Schemes in India .......................................................................8

Overview of existing scheme existed in mutual fund category: ...................................10

TYPES OF RETURNS ..........................................................................................11

ADVANTAGES OF INVESTING MUTUAL FUNDS: ............................................12

WHAT TO LOOK FOR IN A FUND? ..................................................................13

FAQ .......................................................................................................................14

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Ground Rules for Investing

Investing is a complex exercise only because we insist on making it so. But the basic principles aresimple. As simple that anyone can become a good investor just by following simple and easilyunderstood rules, which also help avoid big mistakes. Here are my rules for investment success.

1) Develop a Plan: For your short-term goals, make sure you're taking appropriate risks. Investmoney that you'll need in the next two years to five years in cash and short-term bonds. If you'vetaken on too much risk for short-term objectives, pull back now. There's no telling where the

bottom of this market is. It's better to cut your losses and preserve the money you already have forshort-term goals. For your long-term financial goals, consider equities.

2) Keep It Simple: Buy a diversified equity fund or an index fund for equity exposure and afloating-rate bond fund for fixed income exposure. These are the basics of the investment world.Sure, you can buy many other types of funds (Petro, MNC, Gilt, Fixed Maturity, Serial Plans etc),

but it's hard to go wrong with these two. To keep fund selection simple, stick with a diversifiedequity funds of well-established fund families. Equities prove to be the best performing long-termasset class. Stay away from exotic speciality and sector funds, unless you have a huge risk appetite

and you can take in your stride a 25% loss in a quarter.

3) Ignore the hot stocks and funds: If you buy this year's top-performing fund or stock, beprepared to see it at the bottom next year. The fancy academic expression for this phenomenon is-- Reversion to the Mean. But the old saying explains it just as well -- what goes up must comedown.

4) Invest Regularly: Investing a little bit of money each month is the surest way to reduce therisk of investing, because you lessen the possibility of buying at the market top. Also, no one issmart enough to anticipate all the moves, both up and down.

5) Buy and Hold: Short-term trading makes more brokers than investors rich. The income taxdepartment likes the practice, too. If you meet anyone who claims to have made money throughshort-term trading, resist your temptation to listen any further and move on to a more productiveconversation.

6) Start Early: It is not the "market timing" but time in the market that matters. Power ofcompounding will turn things in your favour.

Investing is a long-term proposition. Research your investments, remember your goals, re-examine your risk, and limit how much you listen to day-to-day market commentary. And don'tlet your emotions overpower your sense of reason.

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All About Mutual Fund Investing

What is a Mutual Fund?

A mutual fund is just the connecting bridge or a financial intermediary that allows a group ofinvestors to pool their money together with a predetermined investment objective. The mutualfund will have a fund manager who is responsible for investing the gathered money into specificsecurities (stocks or bonds). When you invest in a mutual fund, you are buying units or portionsof the mutual fund and thus on investing becomes a shareholder or unit holder of the fund.

Mutual funds are considered as one of the best available investments as compare to others theyare very cost efficient and also easy to invest in, thus by pooling money together in a mutual fund,investors can purchase stocks or bonds with much lower trading costs than if they tried to do it ontheir own. But the biggest advantage to mutual funds is diversification, by minimizing risk &maximizing returns.Mutual Funds are increasingly being touted as the retail investors' investment vehicle. But the keychallenge is to choose the right fund. But it's simple. It only requires a bit of discipline and littletime - hardly a cost for a secure financial future. Following are some rules to help invest better

and attain your financial goals.

1) Know Yourself: The first step towards achieving your goals is that you must know yourself.Try to get an idea of how much risk you can handle. Do a tolerance test for yourself. If your Rs10,000 investment turning into Rs 6,000 upsets you--even though it could subsequently bounce

back--an aggressive equity fund is not for you.

2) Reality Check: What are your goals? If you need to turn Rs 10,000 into Rs 50,000 in twoyears, a medium term bond fund may not be the right answer. Work on setting realisticexpectations for both your goals and your funds.

3) Know What You Are Buying: Once you discovered yourself, spend some time for a closeunderstanding of the funds. The stated objective of a fund as given in a prospectus is oftenincomplete and does not reveal much. Based on the readily available portfolio and fund manager'scommentary, you can broadly understand the style and strategy followed by a fund. This will help

you meaningfully diversify your portfolio. This will also help you assess potential risks. In general,large-cap value funds are less risky than small-cap growth funds.

4) Examine Sector Weightings:You must know that funds with large stakes in just one or twosectors will likely be more volatile than the more evenly diversified funds. Looking at a fund'ssectoral history will help you gain a good perspective. Does the manager move in and out ofsectors frequently and dramatically? If so, the fund might get hurt, if the manager is ever caughton the wrong foot.

5) Check Out the Fund's Concentration: A portfolio with just 20 or 30 stocks or one thatputs most of its assets in just a few stocks will likely be more volatile than a fund that's spreadamong hundreds of stocks. But there could be rewards of concentration. A concentrated portfolio

will also get more bang for its buck if its stocks work out. You may want to add a concentratedfund, one that owns fewer stocks or puts most of its assets in the top 10 or 20 stocks, to yourportfolio.

But largely, your core funds should probably be well a diversified and more predictable. Though asmall allocation to a sector-oriented fund, a more-flexible fund, or a more-concentrated fundcould boost your returns.

6)Assess Performance Appropriately: Past performance is no indicator of future results.Investors should commit this statutory quote from mutual fund prospectus, advertisements and

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any other literature to memory. It should be recalled more readily than your bank accountnumber. It should be repeated anytime you consider sending money to any fund with a 100 percent three-month gain.

Why? Chances are that a few months of boom will be followed by bust, as it has happened in2000. All the ICE concentrated funds, which were topping the charts, fell flat on their face. There

was just no escape when their NAVs started declining like nine pins. What should an investor do?Do not concentrate your mutual fund portfolio or invest in a concentrated fund. And, above all,don't focus on short-term returns. When choosing a fund, look for above-average performance,quarter after quarter, year after year.

7) Know Your Portfolio: Look for areas that are over-represented and for those that arelacking. For example, will your portfolio be overly concentrated in the large-cap equities or toomuch in highly rewarding but wildly volatile infotech stocks? Will you be missing investments insmall-cap stocks?

8) Be A Disciplined Investor: After you've chosen some funds, stick with them. Don't be afraidto go against the tide, as often the unpopular groups tend to outperform in subsequent years. Inother words, small contrarian bets could be lucrative. And discipline is the key. Rupee-costaveraging, or investing a regular amount of money at regular intervals, tends to add value. With a

systematic investment plan, you are likely to beat the fund returns.

9) Know How Much You Pay: Money saved is money earned. So it's always better to pay lessthan it is to pay more. Expenses are very important with your larger-cap, lower-risk funds, andless critical with small-cap funds and other higher-risk categories. For example, be wary of highexpenses when you are considering bond funds. And you can afford to be lenient with the expenseof a small-cap or a sector equity fund.

The nuances of mutual fund investing can be endless. But the strength of the mutual fund idealies in its simplicity. Don't get bogged by the noise and clutter. You could well be on your way toreach your goals by following these basic guidelines and be a smarter investor.

Benefits of Investing in Mutual Funds

AffordableAlmost everyone can buy mutual funds. Even for a sum of Rs 1,000 an investor can invest in amutual fund.

Professional ManagementFor an average investor, it is a difficult task to decide what securities to buy, how much to buy and

when to sell. By buying a mutual fund, you acquire a professional fund manager who managesyour money. This is the person who decides what to buy for you, when to buy it and when to sell.The fund manager takes these decisions after doing adequate research on the economy, industriesand companies, before buying stocks or bonds. Most mutual fund companies charge a small feefor providing this service which is called the management fee.

DiversificationAccording to finance theory, when your investments are spread across several securities, your riskreduces substantially. A mutual fund is able to diversify more easily than an average investoracross several companies, which an ordinary investor may not be able to do. With an investmentof Rs 5000, you can buy stocks in some of the top Indian companies through a mutual fund,

which may not be possible to do as an individual investor.

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LiquidityUnlike several other forms of savings like the public provident fund or National Savings Scheme,

you can withdraw your money from a mutual fund on immediate basis.

Tax BenefitsMutual funds have historically been more efficient from the tax point of view. A debt fund pays adividend distribution tax of 12.5 per cent before distributing dividend to an individual investor oran HUF, whereas it is 20 per cent for all other entities. There is no dividend tax on dividends froman equity fund for individual investor.

Basics of mutual fundsThe article mentioned below, is for the investors who have not yet started investing in mutualfunds, but willing to explore the opportunity and also for those who want to clear their basics for

what is mutual fund and how best it can serve as an investment tool.Getting StartedBefore we move to explain what is mutual fund, its very important to know the area in whichmutual funds works, the basic understanding of stocks and bonds.

StocksStocks represent shares of ownership in a public company. Examples of public companies includeReliance, ONGC and Infosys. Stocks are considered to be the most common owned investmenttraded on the market.

BondsBonds are basically the money which you lend to the government or a company, and in return youcan receive interest on your invested amount, which is back over predetermined amounts of time.Bonds are considered to be the most common lending investment traded on the market.There are many other types of investments other than stocks and bonds (including annuities, realestate, and precious metals), but the majority of mutual funds invest in stocks and/or bonds.

Working of Mutual Fund

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Regulatory Authorities

To protect the interest of the investors, SEBI formulates policies and regulates the mutual funds.It notified regulations in 1993 (fully revised in 1996) and issues guidelines from time to time. MFeither promoted by public or by private sector entities including one promoted by foreign entitiesis governed by these Regulations.

SEBI approved Asset Management Company (AMC) manages the funds by making investments invarious types of securities. Custodian, registered with SEBI, holds the securities of variousschemes of the fund in its custody.

According to SEBI Regulations, two thirds of the directors of Trustee Company or board oftrustees must be independent.The Association of Mutual Funds in India (AMFI) reassures the investors in units of mutual fundsthat the mutual funds function within the strict regulatory framework. Its objective is to increasepublic awareness of the mutual fund industry.

AMFI also is engaged in upgrading professional standards and in promoting best industrypractices in diverse areas such as valuation, disclosure, transparency etc.

DiversificationDiversification is nothing but spreading out your money across available or different types ofinvestments. By choosing to diversify respective investment holdings reduces risk tremendouslyup to certain extent.

The most basic level of diversification is to buy multiple stocks rather than just one stock. Mutualfunds are set up to buy many stocks. Beyond that, you can diversify even more by purchasingdifferent kinds of stocks, then adding bonds, then international, and so on. It could take you

weeks to buy all these investments, but if you purchased a few mutual funds you could be done ina few hours because mutual funds automatically diversify in a predetermined category ofinvestments (i.e. - growth companies, emerging or mid size companies, low-grade corporate

bonds, etc).

Types of Mutual Funds Schemes in India

Wide variety of Mutual Fund Schemes exists to cater to the needs such as financial position, risktolerance and return expectations etc. thus mutual funds has Variety of flavors, Being a collectionof many stocks, an investors can go for picking a mutual fund might be easy. There are overhundreds of mutual funds scheme to choose from. It is easier to think of mutual funds incategories, mentioned below.Overview of existing schemes existed in mutual fund category: BY STRUCTURE

1. Open - Ended Schemes:

An open-end fund is one that is available for subscription all through the year. These do not havea fixed maturity. Investors can conveniently buy and sell units at Net Asset Value ("NAV") relatedprices. The key feature of open-end schemes is liquidity.

2. Close - Ended Schemes:

A closed-end fund has a stipulated maturity period which generally ranging from 3 to 15 years.The fund is open for subscription only during a specified period. Investors can invest in thescheme at the time of the initial public issue and thereafter they can buy or sell the units of the

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scheme on the stock exchanges where they are listed. In order to provide an exit route to theinvestors, some close-ended funds give an option of selling back the units to the Mutual Fundthrough periodic repurchase at NAV related prices. SEBI Regulations stipulate that at least one ofthe two exit routes is provided to the investor.3. Interval Schemes:Interval Schemes are that scheme, which combines the features of open-ended and close-endedschemes. The units may be traded on the stock exchange or may be open for sale or redemptionduring pre-determined intervals at NAV related prices.

The risk return trade-off indicates that if investor is willing to take higher risk thencorrespondingly he can expect higher returns and vise versa if he pertains to lower riskinstruments, which would be satisfied by lower returns. For example, if an investors opt for bankFD, which provide moderate return with minimal risk. But as he moves ahead to invest in capitalprotected funds and the profit-bonds that give out more return which is slightly higher ascompared to the bank deposits but the risk involved also increases in the same proportion.

Thus investors choose mutual funds as their primary means of investing, as Mutual funds provide

professional management, diversification, convenience and liquidity. That doesnt mean mutualfund investments risk free. This is because the money that is pooled in are not invested only indebts funds which are less riskier but are also invested in the stock markets which involves ahigher risk but can expect higher returns. Hedge fund involves a very high risk since it is mostlytraded in the derivatives market which is considered very volatile.

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Overview of existing scheme existed in mutual fundcategory:1. Equity fund:

These funds invest a maximum part of their corpus into equities holdings. The structure of thefund may vary different for different schemes and the fund managers outlook on different stocks.The Equity Funds are sub-classified depending upon their investment objective, as follows:Diversified Equity FundsMid-Cap FundsSector Specific FundsTax Savings Funds (ELSS)Equity investments are meant for a longer time horizon, thus Equity funds rank high on the risk-return matrix.

2. Debt funds:

The objective of these Funds is to invest in debt papers. Government authorities, privatecompanies, banks and financial institutions are some of the major issuers of debt papers. Byinvesting in debt instruments, these funds ensure low risk and provide stable income to theinvestors. Debt funds are further classified as:

Gilt Funds: Invest their corpus in securities issued by Government, popularly known asGovernment of India debt papers. These Funds carry zero Default risk but are associated withInterest Rate risk. These schemes are safer as they invest in papers backed by Government.

Income Funds: Invest a major portion into various debt instruments such as bonds, corporatedebentures and Government securities.

MIPs: Invests maximum of their total corpus in debt instruments while they take minimum

exposure in equities. It gets benefit of both equity and debt market. These scheme ranks slightlyhigh on the risk-return matrix when compared with other debt schemes.

Short Term Plans (STPs): Meant for investment horizon for three to six months. These fundsprimarily invest in short term papers like Certificate of Deposits (CDs) and Commercial Papers(CPs). Some portion of the corpus is also invested in corporate debentures.

Liquid Funds: Also known as Money Market Schemes, These funds provide easy liquidity andpreservation of capital. These schemes invest in short-term instruments like Treasury Bills, inter-

bank call money market, CPs and CDs. These funds are meant for short-term cash management ofcorporate houses and are meant for an investment horizon of 1day to 3 months. These schemesrank low on risk-return matrix and are considered to be the safest amongst all categories ofmutual funds.

3. Balanced funds:

As the name suggest they, are a mix of both equity and debt funds. They invest in both equitiesand fixed income securities, which are in line with pre-defined investment objective of thescheme. These schemes aim to provide investors with the best of both the worlds. Equity partprovides growth and the debt part provides stability in returns.Further the mutual funds can be broadly classified on the basis of investment parameter viz,

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Each category of funds is backed by an investment philosophy, which is pre-defined in theobjectives of the fund. The investor can align his own investment needs with the funds objectiveand invest accordingly.

By investment objective:Growth Schemes: Growth Schemes are also known as equity schemes. The aim of theseschemes is to provide capital appreciation over medium to long term. These schemes normallyinvest a major part of their fund in equities and are willing to bear short-term decline in value forpossible future appreciation.

Income Schemes: Income Schemes are also known as debt schemes. The aim of these schemesis to provide regular and steady income to investors. These schemes generally invest in fixedincome securities such as bonds and corporate debentures. Capital appreciation in such schemesmay be limited.

Balanced Schemes: Balanced Schemes aim to provide both growth and income by periodicallydistributing a part of the income and capital gains they earn. These schemes invest in both sharesand fixed income securities, in the proportion indicated in their offer documents (normally50:50).

Money Market Schemes: Money Market Schemes aim to provide easy liquidity, preservationof capital and moderate income. These schemes generally invest in safer, short-term instruments,such as treasury bills, certificates of deposit, commercial paper and inter-bank call money.Other schemes

Tax Saving Schemes: Tax-saving schemes offer tax rebates to the investors under tax lawsprescribed from time to time. Under Sec.88 of the Income Tax Act, contributions made to anyEquity Linked Savings Scheme (ELSS) are eligible for rebate.Index Schemes: Index schemes attempt to replicate the performance of a particular index suchas the BSE Sensex or the NSE 50. The portfolio of these schemes will consist of only those stocksthat constitute the index. The percentage of each stock to the total holding will be identical to thestocks index weightage. And hence, the returns from such schemes would be more or lessequivalent to those of the Index.Sector Specific Schemes: These are the funds/schemes which invest in the securities of onlythose sectors or industries as specified in the offer documents. e.g. Pharmaceuticals, Software,Fast Moving Consumer Goods (FMCG), Petroleum stocks, etc. The returns in these funds aredependent on the performance of the respective sectors/industries. While these funds may givehigher returns, they are more risky compared to diversified funds. Investors need to keep a watchon the performance of those sectors/industries and must exit at an appropriate time.Types of returnsThere are three ways, where the total returns provided by mutual funds can be enjoyed byinvestors:

Income is earned from dividends on stocks and interest on bonds. A fund pays out nearly allincome it receives over the year to fund owners in the form of a distribution.

If the fund sells securities that have increased in price, the fund has a capital gain. Most fundsalso pass on these gains to investors in a distribution.

If fund holdings increase in price but are not sold by the fund manager, the fund's shares increasein price. You can then sell your mutual fund shares for a profit. Funds will also usually give you achoice either to receive a check for distributions or to reinvest the earnings and get more shares.

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What To Look for in a Fund?

Choosing a mutual fund is not an easy task with so many funds. We think that the correct firststep towards deciding is to decide on a way of deciding. Rarely do investors-normal investors,

who do something else for a living-have a systematic checklist of things that they should evaluateabout a fund, which they are considering buying. Here's our blueprint for a structured approachto fund selection. There are four basic areas that you must evaluate in a fund to decide whetherit's a good investment.

Performance: Performance comparisons must be used only to compare the same type of fund.They are meaningless otherwise. Only when used within the same category of funds doperformance numbers tell you anything at all. By the time you come to the stage when you arecomparing performance numbers of different funds, you should already have a good idea of howmuch you will invest in that category.

Risk: Almost all investing is risky, at least those investments that get you any meaningfulreturns. In general it is said that the riskier a fund, the more its potential for earning high returns,at least most of the time. However, this is a simplified view that implies that a given amount ofrisk always gets you the same returns. This is simply not true because not all funds are equally

well-run.

The true measure of risk is whether a fund is able to give you the kind of returns that justify thekind of risk it is taking.

Evidently, this is not as easy to measure as returns. There are a wide variety of statisticaltechniques that can be used to measure this, and we distil a combination of performance and riskmeasurement into the Value Research Fund Rating. When we say that a fund has a five- or four-star rating, it means that the fund, compared to similar funds, performed better, given its risklevel.

Portfolio: Unlike performance and risk, portfolio is one of the 'internals' of a fund. It is internalin the sense that the result of good, bad or ugly portfolios is already reflected in the first twomeasures and it's perfectly OK for you to choose funds on the basis of those two measures alone

without actually bothering about what they own. Our basic analysis of portfolios measureswhether a fund (we are talking about equity funds here) holds mostly large, medium or smallcompanies. It also looks at whether a fund prefers companies that may be overpriced but whichare growing fast or whether it prefers low-priced stocks belonging to companies that are growingat a more gentle pace. For fixed income funds, an analogous analysis tells one whether a fundprefers volatile but potentially high return long-duration securities or stable and low return short-duration securities. Also, one can analyse whether a fund prefers safer (lower returns) securitiesor riskier (higher returns) securities.

Management: Fund management is a fairly creative and personality-oriented activity. This maynot be true of some types of funds like shorter-term fixed-income funds and, of course, indexfunds, but equity investment is more of an art than a science. When you are buying a fund

because you like its track record (and unless you can foresee the future, that's the only way to buy

a fund), what you are actually buying is a fund manager's (or sometimes a fund managementteam's) track record. What you need to make sure is that the fund manager who was responsiblefor the part of the fund's track record that you are buying into is still there. A high-performanceequity fund with a new manager is a like a new fund.

Cost:While these are the four main points on which to evaluate a fund, there is one more factorthat is becoming increasingly important and that is cost. Funds are not run for free and nor arethey run at an identical cost. While the difference in different funds' cost is not large, these cancompound to significant variations, especially for fixed income funds where the performancedifferential between funds is quite small to begin with. Even for equity funds, it may not be worth

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buying a higher cost fund that appears to be only slightly better than a lower cost one. Remember,there is no reason for one AMC to have much higher costs than others, apart from the fact that it

wants to have a higher margin, or that it wants to spend more on things like marketing, which areof no relevance to you. If an AMC wants higher returns from its business, then it must justify it bygiving you higher returns on your investments.

FAQ

Dividends - Something Extra?

Most mutual fund schemes come in three options - dividend, dividend reinvestment and growth.The fact that under the dividend option the fund keeps on declaring regular dividends and nosuch payments accrue under the growth option might suggest to some investors that the formerare more yielding. However, the truth is that it does not make a dime of difference which option

you choose, from the pure investment-yield point of view. The form in which you choose toreceive the gains might have tax implications though.

When your fund pays out a dividend all it has done is - paid out the gains it has generated insteadof accumulating it. So now the onus of investing this money falls back on you. Moreover, any

dividend paid means that the fund pool is smaller by the amount of the payout and this isreflected in the lower NAV. Had the fund not paid the dividend, it would have been reflected inthe higher NAV of the fund and as a result the value of the units held by you would haveappreciated which you would have realised on redemption. Under the dividend reinvestmentoption, the same dividend amount as paid under the dividend option is paid. However, instead ofan absolute amount, the dividend is paid in the form of higher units issued to the investor.

There is a caveat, though. Investors should opt for that option that minimises their tax liability. Ifdividend income is tax-free (as is the case with dividends from equity funds), then the dividendoption or the dividend reinvestment option is a good bet. If capital gains are tax-free (as is thecase currently with equity-oriented funds) then choosing the growth option would probably bemore viable. If both are tax-exempt, the net returns will be identical from any option.

Is Low NAV Cheap?

Is a fund with a low NAV a better investment option than a fund with a higher NAV? Since youcan buy more units when the NAV is low, isn't it cheaper? Should mutual fund schemes with ahigher NAV be avoided? These are questions, which trouble many first-time investors in mutualfunds.

The answer to these questions is that it is irrelevant how high or low the NAV of a fund is. Theamount of your investment remaining unchanged, between two funds with identical portfolios, alow NAV would mean a higher number of units held and consequently a high NAV would meanlower number of units held. But under both circumstances, the product of the number of unitsand the applicable NAV, which is the value of your investment, would be identical. Thus it is thestocks in a portfolio that determine returns from a fund, the value of the NAV being immaterial.

When one sells those units, the return will be the same as that of another scheme, which hasperformed similarly. The 'cost' of a scheme in terms of its NAV has nothing to do with returns.

What you want to buy in a scheme is its performance. The only instance where a higher NAV mayadversely affect you is where a dividend has to be received. This happens because a scheme with ahigher NAV will result in a fewer number of units and as dividends are paid out on face value,higher NAV will result in lower absolute dividends due to the smaller number of units. But evenhere, total returns will remain the same.

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So from whichever angle you see it, the NAV makes no difference to returns. Mutual fundschemes have to be judged on their performance. And the simplest way to do this is to comparereturns over similar periods.

Monitoring Mutual Fund InvestmentsIf you are one of those who track their mutual fund investments with the same enthusiasm andcare as they put in while choosing where to invest in, then we can assure you that you are in aminority. Most people think that once they invest in a fund, the job of taking care of theirinvestments has been successfully passed on to the fund manager. But this can be a dangerousstrategy to adopt. Let us explain why.

The performance of a fund, especially equity-oriented funds, is to quite an extent dependant onthe calls of the fund manager. If your fund manager quits, the investment style may change, andthe fund's performance could suffer. Hence, you should carefully monitor the fund's performanceany time such changes occur, and exit the fund if its performance dips drastically.

How do you keep track of your fund's performance? All AMCs provide you with their annualreport, a half-yearly report (unaudited results) and a quarterly and monthly factsheet/newsletter.Over and above this, public disclosure of the NAV of a scheme happens on the AMFI website, onthe AMC's own website, as well as in the financial dailies. While NAV information tells you verylittle other than how well your investments are doing, it is basically the portfolio disclosure thathappens through the newsletters and AMC reports that one should be interested in. Also, try togauge the fund's performance vis--vis its benchmark and its peers (at least to the extentpossible).

The fund manager will not tell you when to exit the fund. This is something you will have todecide, based on the information available. So, keep track of the fund's performance. After all, it's

your money and you should know what the fund is doing with it.

Aggressive equity funds*

Reliance Growth-G (333/-)Sundaram BNP Paribas Select Midcap-G (100/-)Birla Mid Cap-G (80/-)HDFC Equity-G (167/-)

Agressive tax saver funds* Franklin India Taxshield-G (145/-)Franklin India Taxshield-D (30)Principal Tax Savings (80)

* - In my opinion.

FDs v/s Debt Funds

Why should one opt for a pure debt fund in place of other safer investments like bank FDs? Thefive star rated debt fund - Kotak Flexi Debt has generated an annual return of 7.28 per cent (ason February 14, 2008) for a three year period, whereas any bank FD would have fetched morethan that.-Rahul Maheshwari

It is true that fixed deposits (FDs) are a safer investment option when compared to debt funds.Debt funds are sensitive to interest rate fluctuations unlike an FD which offers a fixed interest rate

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for a fixed tenure. But the most important difference between these two is the tax treatment ongains. The interest earned on a fixed deposit is to be added on to your income irrespective of theterm of the FD. Further, there is no distinction between short or long term capital gains tax inFDs. This overall reduces the yield of a fixed deposit, especially if you fall in the 30 per cent tax

bracket.

What makes debt funds a better choice is the tax treatment on its gains. Just like FDs, if youredeem a debt fund within one year then you need to add the gains to your income (Short termcapital gains). In case you redeem the investment after one year (long term capital gains) you canavail the indexation benefit.

Spread Your Investments

I have SIPs of Rs 2,000 each in SBI Magnum Global, SBI Magnum Contra and SBI MagnumTaxgain. The dates are with a 10 day gap between each. I would not like to invest in the marketon those days. I try to spread my investments over a month. Is this good? Should I span myinvestments over two years, rather than one? What's your opinion on these funds?-Anand S

It's always good to spread your investments over months and certainly not a bad idea to do so in asingle month too. All it needs is extra management of remembering due dates and ensuring that

you maintain enough bank balance on these dates. Now that you have chosen these funds andspread your investments, avoid adding more funds to your portfolio. The SIP will average out thecost of your purchase.

All the three funds are five-star rated with a good performance track record. But you areoverexposed to one fund house, assuming that this is your entire fund portfolio. You must alsodiversify across various schemes of different fund houses. Why don't you start an SIP in a midcap fund like Sundaram Select Mid Cap or Reliance Growth and discontinue investing in SBIMagnum Global? But don't redeem the already bought units.

For deciding the time period of your SIP, you need to identify your strategy. If you have opted forthese SIPs just to deploy a certain amount, then a one year SIP is enough. If this is an on-goinginvestment then you can continue with a long-term view.

What is

Fixing Value

The Price Earnings (PE) ratio and Price/Earnings to Growth (PEG) ratio are commonly used toolsfor determining the value the market has placed on a stock.

The PE ratio is a common measure of the relative value of a stock based on its Earnings Per Share(EPS). Breaking it down mathematically, PE denotes the amount that you are willing to pay forone rupee worth of the company's earnings. A stock with a high PE ratio suggests that the firmhas strong future earnings growth prospects. But investors perceive a low PE as a bargain buy

because it may well indicate that the stock price has not risen to reflect the earnings potential ofthe company.

On the other hand, the PEG is an improvised and sophisticated version of the PE ratio. Thereason the PEG is more favoured over the PE ratio is because it also accounts for growth.

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The PEG ratio quantifies the relative trade-off between the price of a stock, the EPS and thecompany's expected future growth. By doing so, the PEG ratio determines whether the market

valuation is supported by the predicted future earnings growth rates.

Just like the PE ratio, a lower PEG ratio hints at a better investment opportunity than a higherone. In other words, a cheaper PEG (of two stocks in the same industry) is more favourable thanan expensive one. An expensive PEG means that the price of the stock is probably too highrelative to the estimated future growth in earnings. As a rule of thumb, a PEG of more than 1 isconsidered expensive. Let's say a stock has a PE of 25 times earnings. It appears high, but not if

you take into account a projected earnings growth of, say, 30 per cent. Its PEG would be a low0.83 (25 divided by 30). The lower the number, the less you pay for each unit of future earningsgrowth. So even a stock with a high PE, but high projected earning growth, may be a good value

buy.

At the same time, alow PE would not necessarily mean a good bargain but just an indication ofgraver issues.

A stock may have a low PE but have very low or no projected earnings growth. In such a situation,

the high PEG may not offer value. Let's say the PE is 8 and earnings growth is projected to be flat.That would mean a high PEG of 8, a very expensive investment.

Ultimately, PEG is about year-to-year earnings growth. But since it relies on projections, it maynot always be accurate.

Alpha and Omega

Alpha, as you may know, is the first letter of the Greek alphabet. But when analysts use it in thecontext of modern portfolio theory, Greek is far from their mind.

Alpha tells you whether the fund has produced returns justifying the risks it is taking. It does this

by comparing its actual return to the one 'predicted' by the beta. Say, a fund can be expected toearn a return of 15 per cent in a year (based on its beta). However, it actually fetches you 18 percent. Then the alpha of the fund is 3 (18 - 15 = 3). In other words, alpha is a measure of selectionrisk (also known as residual risk) of a mutual fund in relation to the market. A positive alpha isthe extra return awarded to the investor for taking a risk, instead of accepting the market return.

Alpha can be seen as a measure of a fund manager's performance. This is what the fund hasearned over and above (or under) what it was expected to earn. Thus, this is the value added (orsubtracted) by the fund manager's investment decisions. A passive fund has an alpha of 0. That's

why index funds always have-or should have, if they track their benchmark index perfectly-analpha of 0. An active fund's alpha is a measure of what the fund manager's activity hascontributed to the fund's returns.

Alpha is the portfolio's risk-adjusted performance or the value added provided by a manager.Mathematically, alpha is the incremental difference between a manager's actual results and hisexpected results, given the level of risk. A positive alpha indicates that a portfolio has producedreturns above the expected level--at the same level of risk--and a negative alpha suggests theportfolio underperformed given the level of risk assumed. So two fund managers may beat thesame benchmark, but only one may outperform on a risk-adjusted basis. That one has got thealpha.

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Alpha is one of the five technical risk ratios used in Modern Portfolio Theory. The other four arebeta, R-squared, standard deviation and the Sharpe Ratio. All these statistical measurements helpinvestors determine the risk-reward profile of a mutual fund.

Sharpening Skills

The downside risk of investing is a reality that must be given due importance. As is widelyaccepted, high returns are generally associated with a high degree of volatility. For this purposethe performance of a portfolio must be viewed with respect to the risk assumed. It is here that theSharpe Ratio comes in handy. For the Sharpe Ratio assesses the return generated by a portfolio,per unit of risk undertaken. Risk in this case is taken to be the portfolio's standard deviation.Standard deviation is used as it is indicative of the volatility in the fund. A lower standarddeviation implies little fluctuation in the returns.

Mathematically, the Sharpe Ratio is the difference between the portfolio's returns over and abovethe return earned on a risk free investment divided by the standard deviation of the portfolio. Ahigher Sharpe Ratio is therefore better as it represents a higher return generated per unit of risk.

Take for instance two portfolios A and B (see box). At first glance A has definitely performedbetter but what remains to be seen is the amount of risk assumed for that 15 per cent return. Wehave considered the bank deposit rate as the risk free rate of return at 3.5 per cent. The resultantSharpe Ratio for portfolio A at 1.64 and that for B at 1.87 means that portfolio B is capable ofdelivering additional returns vis a vis portfolio A for any additional risk that may be assumed.

Portfolio Returns (%) Standard Deviation Sharpe Ratio

A 15.00 7.00 1.64B 11.00 4.00 1.87

This process of comparing the risk adjusted returns of two portfolios, gives us an insight into theefficiency of fund management as well. Because a portfolio could deliver superlative returns byassuming significant risk, but a superior portfolio is arrived at when the manager is able torationalise the amount of risk taken to deliver high returns.

However, while looking at Sharpe ratio, please keep in mind that in isolation it has no meaning. Itcan only be used as a comparative tool. Thus the Sharpe ratio should be used to compare theperformance of a number of portfolios or funds. In case of mutual funds, one can compare theSharpe ratio of a fund with that of its benchmark index. If the only information available is thatthe Sharpe ratio of a fund is 1.2, no meaningful inference can be drawn as nothing is known aboutthe peer group performance. Another aspect to look out for is that the ratio can be misleading attimes. For example, a low standard deviation can unduly influence results. A fund with lowreturns but with a relatively mild standard deviation can end up with a high Sharpe ratio. Such afund will have a very tranquil portfolio and not generate high returns.

Beta Version

Say the word beta to a tech professional and an investor and each will interpret it differently. Thetech professional will instinctively think of the software implication. Beta, as most of us wouldknow, is the last leg of the software testing phase. It is not the final version of a product or website

but close enough to show in public and work the bugs out.

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Now ask the finance professional or investor and he will immediately think of volatility. Simplyput, beta is the measure of a fund's (or stock's) volatility relative to the market or the benchmark.

Assume a fund is benchmarked against the Sensex. A beta of more than 1 implies that the fund ismore volatile than the market. A beta of less than 1 implies lesser volatility.

Let's say that there are two funds, one with a beta of 2.5 and the other, 0.4. If the market rises 1per cent, the fund with a beta of 2.5 will rise by around 2.5 per cent and the fund with a beta of0.4, will rise by 0.4 per cent. The similar relationship will take place in a falling market. So beta isa quantitative measure of the volatility of a fund or stock relative to the market.

Beta & YouEssentially, beta expresses the fundamental tradeoff between minimising risk and maximisingreturn. A fund with a beta of 1 will historically move in the same direction of the market. A betaabove 1 is more volatile than the overall market, while a beta below 1 is less volatile. So while youcan expect a high return from a fund that has a beta of 2, you will have to expect it to drop muchmore when the market falls.

The effectiveness of the beta depends on the index used to calculate it. It can happen that theindex bears no correlation with the movements in the fund. For example, if beta is calculated for a

large-cap fund against a mid-cap index, the resulting value will have no meaning. This is becausethe fund will not move in tandem with the index.

Being fairly straightforward, beta offers a lucid, quantifiable and convenient measure whichmakes it easy to work with. However, it has its limitations too. Beta is a historic tool that does notincorporate new information. For instance, a company may venture into a new business andassume a high debt level. Yet, the beta will not capture this new risk taken on. Since beta relies onpast movements, it cannot be used for new stocks that have insufficient price history to establish areliable beta.

Finally, beta is just an indication. It relies on past price movements which are not foolproofpredictors of future behaviour.

Happy InvestingHappy Investing

This material is for reference only; the author is not responsible for any bad investment choicesmade by the reader and their outcome.

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Refrences:

1) www.valueResearchOnline.com

2) www.myIris.com.

ThankYou

Copyright 2008 Amey Joshi TM, Pune.

Edition I 2008.

All rights reserved.

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