Factors influencing the investments decisions of retail investors in Mutual funds
The nature of the fund, performance, company services, fund manager, and personal factor
When bonds of a particular company get downgraded by the rating agencies
The factors identified by the factor analysis for the investment decisions of retail investors in mutual funds are the nature of the fund, performance, company services, fund manager, and personal factor. The important variables in the ‘nature of fund’ are fund objectives and sponsor’s credibility, whereas the essential variables in the performance factor are dividend and expenses charges. Various parameters affect the decision-making of investors in the mutual fund industry. Let’s discuss these factors in brief.
We all know the disclaimer-All the investments in the mutual fund and securities are subjected to market risk. Therefore the NAV of the schemes may vary as per the factors and forces affecting the securities market. As per regulation, all mutual funds also required disclosing the risk factors which are faced by the funds in their offer documents and thus, by the offer documents/SAI/SID/KIM, the investors may know about the different aspects of the fund.
1. Market Risk
All the risks associated with a mutual fund investment can be grouped as market risk. Stock prices are always sensitive to what is happening in an economy locally, at the national level or, internationally. The performance of an economy has an inverse correlation with the risk involved. This market risk may include:
i) Country Risk: The risk in foreign investment changes due to the political instability in a country where the investment was issued.
ii) Political Risk: The risk in national investment changes because of political instability in the home country like political unrest, government regulations, terrorism and other social changes.
iii) Interest Rate Risk: Long term and fixed income securities such as bonds and preferred stocks have the greatest amount of interest rate risk while shorter-term securities such as treasury bills and money market instruments are usually less affected
iv) Currency Risk: It refers to the possible changes in the price of one currency which will affect another. If the currency of the home country declines against foreign currency, the investment will lose value.
2. Liquidity Risk
Liquidity risk means the possibility that an investor may not be able to buy or sell an investment as and when required or in sufficient quantities because of the limited opportunities. The liquidity of a stock depends upon the nature of the fund. Investment in equity funds holds volatility from time to time, whereas debt funds hold a risk of interest rates.
3. Credit Risk
This refers to the possibility that a particular bond issuer will not be able to make expected interest rate payments and/or principal repayment. When bonds of a particular company get downgraded by the rating agencies, credit risk occurs, causing lower prices. There is a risk whether the fund has been invested in higher grade investment securities as a company can default in terms of paying interest or principal or both. It can also be termed as Default Risk.
It is the percentage increase or decrease in the value of the investment in a particular period. The return on mutual funds can be calculated in three different degrees:
1. Absolute Return (Point to Point Return): It is the simple increase (or decrease) in investment in terms of percentage. It does not take into account the time taken for this change. The absolute return method is used if the tenure of investment is short, which is less than 1 year.
2. Compounded Annual Growth Rate (CAGR): CAGR method is used to calculate the return for the period beyond one year for the investment in mutual funds. These are annualized in the compounding effect. Hence it is also known as Annualized Return.
3. Total Return: This method overcomes the limitation of Absolute Return by including dividends.
Before the global financial crisis, liquidity factors of any investment were not on everybody’s radar. Liquidity risk can be categorized as:
1. Funding (Cash flow) Liquidity:It tends to manifest a credit risk that is the inability to fund liability and produces defaults. The basic ways of its measurement are current ratios and quick ratios.
2. Market (Asset) Liquidity: It tends to manifest as market risks meaning inability to sell an asset at the time of requirement i.e., the market price indecipherability of a stock. The market liquidity of an investment can be measured in respect of width (bid-ask spread), depth (position size) and resiliency.
However, mutual funds are required to fulfil shareholder redemption requests within seven days. Therefore, funds should maintain sufficient liquidity in order to meet redemptions and to minimize the impact on remaining shareholders.
The consistency of a fund’s performance can be measured in terms of its performance with respect to its benchmarks and category average. In a bearish mode market, the returns may be negative, but the funds that fall less than their benchmarks or category average are outperformers.
Similarly, in the bull market, the outperformers are those that gain more than their benchmarks or category averages. Such funds beat the market and entail superior and advanced fund management skills. CRISIL accords special importance to consistent performers. As such, they have a separate ranking based on consistent returns.
The awareness level of mutual funds can be termed as the first and foremost stage for investment in any such fund for an investor. According to a survey, if the investors have been provided more funds, 50% of the investors would like to invest in the Real Estate, followed by 23% in Mutual Funds and only 2 % in Equity Shares.
Another survey disclosed that high salaried and high income self-employed people are major investors due to tax concessions. It was observed that small businessmen, farmers, and persons belonging to rural and semi-urban areas in the low-income group had no awareness about mutual funds.
Recent innovations and growing complexities in financial products add enormous pressure on investors. A financially ignorant person suffers from financial diseases like underinsurance, debt trap, insufficient retirement funds and low return on investment. Therefore financial literacy plays a vital role in making informed decisions about their financial futures, and this is also vital if mutual funds are to extend their reach to smaller towns.
Three-fourth of Indian adults do not adequately understand key financial concepts such as inflation, compound interest and risk diversification, Standard & Poor’s Ratings Services said. This is even lower than the global financial literacy average. Talk to your advisor and be well aware of making investment decisions in mutual funds.
That’s why Comparte Investment team asks do you have “Nivesh Ki Aadat”.