Why Mutual Fund Returns Dip?

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 1^st April 1979 has grown to 30,857 today (29^th 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

• What Will Be One Year Mutual Fund Return?
• Why My Friends Lost or Earned Only Meger Returns from Investments in Both Stocks and Mutual Funds?
• Value Investor Buys From A Pessimist And Sells To An Optimist

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. 

What is Listing of Shares in Stock Market?

Listing of shares in the stock market is the act of registering the share for public trading in a stock exchange. This is a very important step that brings liquidity to the share and the financial investment. The advent of online digital platforms has enhanced this liquidity many folds. A decade back stockbrokers used to jostle and shout the bids inside the stock exchange.

The Initial Public Offer (IPO) is a very important step that precedes listing. So let us study IPO in a bit more detail and revisit listing thereafter.

Initial Public Offer (IPO)

An IPO is the act of sale of its shares by the company to the public. Sometimes the original promoters may liquidate a part of their share holding along with new issue of shares by the company. In a few rare cases the sale of shares to the public may comprise of only liquidation of existing shares by promoters of the company. The following table will demonstrate the three scenarios:

An initial public offer of shares is cumbersome and time-consuming process. First of all law shall permit it. For example a private company cannot sell shares to the public. In case a private company wants to go public, it must first convert itself into a public company. Next the issue must comply with the stock market regulations and the regulators (Securities and Exchange Board of India (SEBI).

The general steps of an initial public offer in India are as follows:

 The prospectus is a very important document based on which the investors decides to make an investment in the company. Therefore due care must be taken both by the company and the merchant/ investment banker. It must be factually correct. Future prospects should be estimated on a conservative basis. If things are over promised in the prospectus and if an investor suffers a financial loss he or she may file a lawsuit.

The shares are sold aggressively through stockbrokers. Today people can subscribe online, circumventing the tedious paper based process.

The company allots shares based on a process, at a price. The proportion of number of shares allotted to the number applied depends on how many times the public issue is oversubscribed.

This completes the process of sale of shares to public.

Listing in Stock Exchange

Returning back to listing, the company can list on one or more stock exchanges. In India the ‘Bombay Stock Exchange (BSE)’ and the ‘National Stock Exchange (NSE)’ are the most popular stock exchanges. BSE is the oldest and situated on the famous ‘Dalal Street’, which is the Indian version of the ‘Wall Street’ in New York, in the USA. Usually Indian companies list their shares on both the stock exchanges.

Often listing of a company’s shares in a stock exchange is accompanied pomp and ceremony. In the BSE the ceremonial bell heralds the listing.

Listing Gains

Depending on the popularity, size, profitability and fundamental financial strengths of the company the shares after listing can trade at much higher prices than at which the investors bought them in the IPO. These are called listing gains. Many speculative investors try to profit from such gains. Indigo airline is a good example of listing gains. The issue price was Rs.765 a share. On the listing day the share opened at Rs.856 on the BSE, touched a high of Rs.898 and closed at Rs.878.45, a listing gain of 14.83%.

Sometimes these expectations backfire. Jet Airways’ share, which was issued at Rs.1100, traded on the first day at Rs.1305, a gain of 18.63%. However, the next day the share closed at Rs.420.75, less than half its issue price.

Over Pricing the Issue

In India a very bad practice of overpricing the issue is widespread. This practice resulting extracting the entire value by the company leaving very little for the investors.

India’s beigest issue, Coal India is a typical example.

Coal India shares were issued at Rs.245. On listing (4^th November 2010) they opened at Rs.291 and closed at Rs.343, with a initial listing gain of 40%. Today, on 23^rd June 2017, the share is languishing at Rs.244.25.

What have long-term investors gained by purchasing the shares in the last seven years?

This is not an isolated case but a normal trend.

That is why I do not buy shares through an IPO.

You will always get an opportunity to buy the shares at lesser prices at a latter date.

Related Articles:

• Is it a good idea to purchase shares through an Initial Public Offer (IPO)?
• How to Calculate the Intrinsic Value Shares?
• You Only Find Out Who is Swimming Naked When The Tide Goes Out
• Margin of Safety

To conclude, listing of shares in a stock exchange is a process that enables trading in the shares and endows liquidity to the investment in the shares.