Thursday, June 29, 2017

Why Mutual Fund Returns Dip?

mutual fund return

Investors are often alarmed to see that their mutual fund nav (net assets value) has fallen, some times even to the extent of 25%, in a year. The question, “Why Mutual Fund Returns Dip?” begins to torment them. They wonder whether they have invested with the right fund house that ensures best mutual fund performance. But the truth is that most of the times these doubts that nag investors are unfounded.

How can we say that these genuine suspicions are unfounded?

In reality the fault most often lies in our understanding of how investments work and very high mutual fund performance expectations.

As far as the flaws in our understanding as to how investments work, there are two fundamental issues as follows:
  1. Wrong definition of the term mutual fund return
  2. Assessment of the mutual fund performance within a very short time


Let us examine both the points in a little more detail.

Correct Measure of Return:

The whole investment world, including the mutual fund industry is doing a disservice to the investors as well as to itself by measuring return purely in terms of short-term price fluctuations caused by market forces, of the underlying assets, that is stocks.
Whereas the actual return comprises of:
  • Copious regular dividends distributed by excellent companies over long periods of time – for example a company like NMDC Ltd.’s dividend amounts to over 10% of its price. This means the investment pays back the investment in less than 10 years. If you hold the share of NMDC for 30-40 years dividend itself pays back three to four times the original investment.
  • Occasional special dividends distributed by good companies – for example Hindustan Zinc Ltd. rewarded investors with a special dividend of 1,375% which translates into Rs.27.50 per equity share with a face value of Rs.2. The total amount of dividend paid out by the company was Rs.13,895 Crores or US$ 2.08 billions.
  • Bonus Shares issued again by wonderful companies, not only significantly enhance the return on investment but also yield additional regular and special dividends on these bonus shares.
  • Long-term Capital Appreciation: The final component of the return is the capital appreciation or price increase attained not on account of market fluctuations but on the basis of economic growth of the world, country and finally the company – for example BSE Sensex which stood at 100 on 1st April 1979 has grown to 30,857 today (29th June 2017), a whopping 308 times growth over the past 38 years, on the back of growth of economy and consequently the companies that constitute the Sensex and not due to short-term market fluctuations.

A person who invests in shares for long-term, say two to three decades and reaps the above benefits directly. Mutual fund investors too can enjoy the same benefits provided they hold on to the investments for such long periods. However they are misled by so-called mutual fund returns or mutual fund nav, calculated based on short-term price fluctuations, and sell their holdings, and end up missing the huge wealth creating opportunity.


Assessment over short time spans

Short-term market fluctuations could be steep. Sometimes market can loose up to 60-70% or more in a year. Again after correcting sharply, market could remain depressed for two, three or even five years. Such depressed prices get reflected in the mutual fund return or mutual fund nav.

Investor should not be bothered by such conditions. In fact higher negative return, investors should feel merrier, for this means valuable mutual fund units are available at steep discounts – they should lap up the opportunity and pump cash in. But, alas many investors, having misunderstood how to measure returns, either stay away from investing or worse still sell of their investments at a loss.

Suggested Further Reading



Conclusion


Mutual fund return or mutual fund nav dips owing to short-term market fluctuations in the prices of the underlying stocks comprising the funds. Measuring the so-called returns and assessing mutual fund performance purely based on such dip in returns is a great folly and deters investors from enjoying phenomenal real returns by buying into mutual funds when the returns are negative and holding onto the investments for two to three decades unmindful of such dips on the way. 

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