Where Mutual Funds are lacking for Equity Investors?

Are mutual funds as lucrative for HNI investors, as they used to be?

Mutual fund investment has increasingly become a popular investment tool recently. With the retail investors entering the domain and stricter regulations from SEBI, is a mutual fund as lucrative for HNI investors, as it used to be? Here are the major drawbacks of mutual funds that HNI investors must be aware of, going forward.

Facts about equity mutual fund, investors must be aware of:-

Behavioural Flows – This is among the major drawback of mutual funds. As the retail investors have started investing in the mutual funds, these are highly impacted by the behavioural flows of the uninformed investors. The ‘Loss Aversion Bias’ highly impacts these new investors. They act in haste to prevent short term losses and withdraw the money when the market falls. Exiting the investment at this stage, when conversely, the informed HNI investors add more funds, leads to losses for the entire pool. Hence, the strategy of the HNI investors fails to play out. Over longer time frames, the stock market tends to recover eventually but the reduction in the funds does not allow the fund manager to make an investment when the opportunity arises.

Additionally, the retail investors are also affected by the ‘Action Bias’. These investors invest for short term gains. The action bias forces them to constantly tweak their portfolio by taking profits too frequently and redeeming for short term goal fulfilment. On the other hand, HNIs tend to invest in a longer-term but are unable to make equivalent profits due to such behavioural flows.

Restrictive Latitude of Stock Universe – To protect the interests of the retail investors, broad investment guidelines have been laid down by SEBI on target universe of stocks for mutual funds. Clear definition of what constitutes the small, mid and large-cap stocks has been given. Also, the portion of the fund’s assets that can be invested in these categories has been specified by SEBI. This restricts the judgment of the fund manager. Also, while it makes the investment less risky, it restricts maximum potential performance.

Allocation per stock / per sector – As per the directions are given by SEBI, a mutual fund manager is not allowed to invest more than 10% of the portfolio in a single company. Hence, while a standalone investor may reap higher gains by investing more in a stock that grows over time, a mutual fund is limited by 10% of the portfolio amount. There are caps on the exposure that can be taken by a scheme to a particular group, sector or security.

Over – Diversification – While diversification in mutual fund investment is beneficial as it averages the risks of loss, the same tends to dilute returns for informed equity investors who clearly invest with long term horizon. A minimum level of diversification has been set by SEBI, as stated above, which lowers the risks and the potential for higher gains as well.

Scheme categorization + Allocation limits + Min diversification limits = Less flexibility for the fund manager to operate and show outperformance by way of picking companies outside of the universe.

Investment is all about making informed decisions. When one goes for equity and also makes up the mind for investing with 5 to 10 years of the horizon or more, one deserves a maximum potential return. This is where a well-researched concentrated style of investing generates better performance. This is where mutual funds lack over Portfolio Management Services.