MF Myth Busting - 3

Despite having garnered close to Rs 19 lakh crore (19 trillion) in assets, Mutual Funds remain one of the most misunderstood investment products available today. In this series of articles, we've taken it upon ourselves to lend clarity to the concept of MF investing, by busting the most commonly held myths, three at a time. Here go the next few:

GILT Funds Are Risk Free
GILT Funds or G-Sec funds invest their moneys into government securities. The nomenclature often misleads investors and clients into the fallacious belief that they are "risk free" in nature. This couldn't be further from the truth. Although it's a fact that GILT securities have very low default risk, their prices are heavily sensitive to changes in yields. Bond yields can move up or down depending upon sovereign risk or interest rate changes, among others. For instance, if the RBI were to raise interest rates, yields would go up in tandem and the prices of G-Secs would take a hit, thereby impacting the NAV's of GILT oriented funds negatively. When S&P downgraded India's sovereign ratings in 2009, GILT fund NAV's sank like a stone, much to the consternation of debt investors who harbored the misguided notion that they were investing into a risk-free product!

FMP's Provide A Guaranteed Return
FMP's or "Fixed Maturity Plans" are a type of close ended debt fund that invest money into bonds, with the intent of holding them to maturity. In this manner, they eliminate interest rate risk, and purely retain the default risk associated with bond investing. Perhaps due to the word "fixed" being present in their name, FMP's have led many investors to believe that they provide a "fixed" or guaranteed rate of return. However, this isn't true. Until 2010, fund houses could release data on "indicative yields", which were, as the name suggests, an indicative return that the FMP could provide, if none of the bonds in its portfolio defaulted. However, this practice was banned by SEBI in 2010, as many Advisors were misusing this information to tout FMP's are a "Fixed Return" product. Bear in mind that FMP's carry the risk of bonds in their portfolio defaulting, impacting their final rate of return.

Dividends Are Amounts Earned Over And Above Your Fund Value
Each year, thousands of misguided MF investors select the "dividend" option of a fund over the "growth" option, due to the misguided notion that the former will provide them incremental returns over the latter, through dividend payouts. However, this really isn't the case. Dividends are essentially nothing more than a chunk of your own investment, paid out to you by the Asset Management Company. After a dividend is paid out, the NAV (price of your units) falls by an extent that reduces your fund value by the amount of dividend paid out. For instance, if your fund value prior to the dividend payout is Rs 1.2 lakhs, and the fund pays out a dividend of Rs. 20,000, the fund's "cum-dividend" NAV will fall to the extent that your fund value will fall to Rs 100,000!