Are Small and Mid-Cap Mutual Funds Good for Investment?

Actual Question:

Should I continue investing in Franklin smaller companies and an L&T midcap fund? How are these 2 funds for long-term investment?

I am 22 years old and currently I am investing in these funds through SIP ₹4000 each. And by long term I mean 10–15 years. Also if you can suggest some more funds to add in my portfolio since I can spare an additional ₹3000 SIP.

Answer:

Dear Friend!

I am sorry, I should point out two discrepancies in your present investment strategy:

Investing in small-cap and mid-cap companies.

It seems that you are investing in costly, actively managed mutual funds.

Small and Mid-Cap companies:

One should always invest in companies that are large. Why?

1. In the first place, Large companies have become to that stature because they have some inherent strengths/ advantages.
2. They can attract financial resources, when required, at competitive rates to implement major expansions, technological up-gradations, etc.
3. They have the resilience to recover from major mistake in case they happen to make a few.
4. At times of a market meltdown large and mid sized comapnies bear the maximum brunt. Large companies though affected escape with just bruises.

 In my case, when investing in shares directly, I make sure that the company has a minimum turnover of Rs.10000 crores (US$ 1.5 billion) and a market capitalisation of an equal amount. These companies will typically fall under the mid-cap segment, but are a select few with extremely good fundamentals. But mutual funds’ inclusion criteria are more biased towards considerations like price momentum, sectoral prospects, etc., rather than company fundamentals.

Costly, Actively Managed Funds:

Actively managed funds are funds that undergo frequent changes by buying new stocks and selling existing ones, with an purported aim of maximising returns. However history proves otherwise. The fund management fee charged for active funds ranges between 3–4% per annum. You can imagine the total fees charged by the fund over an investing period of 15 to 20 years!

Investor in mutual funds will benefit by investing in well diversified, low cost index mutual funds or exchange traded funds. The fund management fees for such passive funds are below 0.5% per annum.

Your Particular Situation:

Finally coming to your personal investment situation, I suggest that you stop your existing SIPs and start a SIP of:

• SBI ETF (Exchange Traded Funds) BSE 100
• LIC MF ETF - Nifty 100
• ICICI Prudential CNX 100 iWIN ETF

Please note that I have not recommended the above based on any returns or performance but simply because:

• They are low cost, exchange traded funds.
• The fund are operated by large financial institutions that you can expect to be in business for the next 100 years
• They are composed of the Top 100 Indian companies.

Suggested Further Reading:

• Types of Mutual Funds
• How to Choose the Right Mutual Fund to Invest?
• What is an Exchange Traded Fund?

Thank you,

With Best Regards

Anand

Which ETF Has Lowest Cost and Tracking Error?

Actual Question:

Which are the index ETFs in India with the lowest cost and tracking errors?

Answer:

Dear Friend!

Thank you for posing the valuable question.

My answer is that I have not gone into researching these two aspects as in my opinion the outcome of such a research may not yield any significant benefits as the variance maybe minimal.

Now let us take each point individually.

Lowest Cost of ETF:

While there is a huge cost difference between an actively managed mutual fund and an index fund or an Exchange Traded Fund (ETF), competition generally will force the cost difference within each class to be negligible. To elaborate, the annual management fee for an actively managed mutual fund is between 3.00 to 4.00 percent. The fund management fee for index funds and ETFs is below 0.50%.

When we are talking about a very, very long time horizon of investments of a minimum of 30–35 years, for ETFs internally compounding at over 15% per annum, generating an unimaginably huge wealth by the end of that period, a difference of 0.01 to 0.02 percent between various ETFs is not going to matter much.

Lowest Tracking Error:

Basically tracking errors arise when there is a time difference or gap between the change in the index and implementing the corresponding change by the ETF in its own fund.

Again as already explained, small tracking errors are not going to impact the results in any significant way.

What the investor shall actually focus on:

What the investor should actually focus on is work on own temperament and mental framework with respect to the following important aspects of investment:

1. Incase of small monthly investments, making investments with strict discipline every month, over such long periods like 30–35 years.
2. To follow the rule, “invest first; spend next” over such long periods.
3. Keeping investments absolutely intact, without disturbing, selling or liquidating for 30–35 years.

Thank you,

With Best Regards

Anand

Exchange Traded Fund Example Slide

Exchange Traded Fund Definition

Definition:

Exchange Traded Fund or ETF is special kind of a mutual fund, which is created and issued by a fund house, whose units are listed on stock exchanges alongside stocks and freely traded like stocks. The ETFs are created based on various underlying assets like stocks, bonds, gold, commodities, or a popular index like ‘BSE Sensex’. The advantage over mutual fund units is that the investor need not approach the mutual fund for redemption and can simply sell on the stock exchange, bringing liquidity to the instrument. The fund management charges are also lower compared to mutual funds since ETFs are passive funds involving minimum time and efforts of fund managers.

Example:

A Few ETFs of Goldman Sachs