Saturday, 27 January 2018

Mutual Funds: Sahi hai! par hai kya?

Switch on your TV and you’ll get an Ad “Sahi hai”, watch a video on you tube and again you’ll hear “Sahi hai”, yeah! everywhere around you’ll find people saying “Mutual Fund Sahi hai”. But in this article I’ll talk about “Sahi hai, par hai kya?” You must have watched those creative ads where mutual fund is being explained in the simplest terms, but 30 seconds might not be sufficient to help you understand the concept of “Mutual Funds”.
So, let’s start with the history, the mutual fund was born from a financial crisis that staggered Europe in the early 1770s. major factor leading to the crisis was the unprofitable expansion of British East India Company which had borrowed heavily for its ambitious expansion plan. That was the time when a Dutch merchant, Adriaan van Ketwich, had the foresight to pool money from a number of subscribers to form an investment trust – the world’s first mutual fund – in 1774. He then diversified the money by investing it across different European countries and American colonies thus minimizing the risk of small investors. This was a close ended fund (will discuss about close ended funds later). People found such funds as safe and attractive and soon the concept of “pooled funds” spread from the Netherlands to England and France before heading to the U.S. in the 1890s.
The first modern-day mutual fund, Massachusetts Investors Trust, was created on March 21, 1924. However, the The stock market crash in 1929, the Great Depression, and the outbreak of the Second World War slackened the pace of growth of the mutual fund industry. But, thanks to the innovation in mutual fund products and services which helped in regaining its popularity during 1960’s. One more reason for its popularity can be accredited to the Canadian mutual funds, which survived well (mainly because of tighter mortgage rules and a regulated banking system) during the market crash in 2008.
So, from the historical background, we come out with some important words:
“small investors”, “Pooled fund”, “Diversification”, “Risk Minimization”, “Innovation”
Thus a mutual fund is a financial intermediary that pools the savings of investors for collective investment in a diversified portfolio of securities. A fund is “mutual” as all of its returns, minus its expenses, are shared by the fund’s investors in proportion to the number of units owned by them. Thus a Mutual Fund is the most suitable investment for the common man as it offers an opportunity to invest in a diversified, professionally managed basket of securities at a relatively low cost. Diversification minimizes the risk making it a safer alternative to direct investing in the stock market.
But do all investors have the same risk appetite? Certainly not. Here comes the role of innovation. The mutual fund companies started tailoring the products according to the risk appetite and financial goal of different investors. Thus they created equity, debt or hybrid funds, then further classified them, for example equity fund may invest in larger companies (Bluechip funds), medium sized companies (Mid cap funds) or in smaller companies (small cap funds) or may have capital allocated to different sized companies (multi cap funds).  I will talk in detail about the different types of funds and the advantages of mutual funds in my other articles.

Happy Investing!