Stocks and mutual funds: Note the difference

Equity and equity-oriented MFs offer stock market-related returns, but they are different instruments

Investors have a misconception about equity mutual funds regarding their pricing, dividend, listing gains, etc. Some think that a high Net Asset Value (NAV) for an equity MF means a costlier fund, high dividend distribution means better performance, there can be listing gains in case of a New Fund Offer (NFO) of an equity fund, etc. Some of the misconceptions can be attributed to bad selling by financial advisors and, to some extent, by the advertisements brought out by fund houses.

Basically, an equity fund gathers money from a number of investors and invests in various stocks. The performance of the portfolio is measured by the increase or decrease in NAV. Although equity funds have similar market risk and return characteristics as equity, they have some fundamental differences, too. Let's look at some of these.

Primary market offers: Public companies and fund houses come out with new offers in the market. They are known as initial public offering (IPO) and New Fund Offer (NFO), respectively. An IPO of equity shares may give handsome returns on listing due to a lot of demand from investors in the secondary market. However, an NFO from a mutual fund may not give astonishing returns, as the NAV of an equity fund reflects the market value of the stocks held by the fund on any day. As a fund holds several stocks in its portfolio, the NAV can only reflect the combined returns on the portfolio of equity invested between the NFO and the date of first NAV. The appreciation in portfolio of stocks of equity funds during such a short time may not be much.

A higher NAV does not mean high price: Another misconception is that a high NAV means the fund is costlier. That's not the case, as a fund reflects the market value of the stocks held by the fund on any day. If the NAV is very high, it need not be that it is costlier. The reason for a high NAV could be that the fund has been in existence for a longer time period, not that a large dividend has been distributed by the fund or the performance of the stocks in which it has invested is good.

There is a difference between the price of a listed security and the NAV of a mutual fund scheme. Listed security has a price determined by the demand and supply of the security. Whereas, the NAV of the scheme has a value determined mathematically, by the prices of the securities in the portfolio.

For example, an investor invests in two funds with a NAV of Rs 20 and Rs 50. If the market in general appreciates by 10 per cent, the Rs 20 NAV will move near Rs 24 and the Rs 50 NAV will move towards Rs. 55. So, in spite of investing in an NAV with different price value, the return your investment will fetch is 10 per cent only.

To take a case, let us see the NAV of HDFC Equity Fund-Growth. As on June 10, it was Rs. 244.24. It was launched in 1995, whereas the NAV of Fidelity Equity Fund is Rs 31.85, launched in 2005. The one-year return given by HDFC Equity Fund was 37.77 per cent, whereas that of Fidelity Equity Fund is 31.11 per cent. Although the per-unit value of HDFC Equity Fund is higher, the return is better than Fidelity with a lower NAV. Of course, they have different benchmarks in the form of CNX 500 and BSE 200, respectively.

Investors are advised not to concentrate on lower NAV and more number of units. It is worthwhile to consider other factors (performance track record, fund management, volatility) that determine the portfolio return.

Dividends: The dividend paid by an MF is distributed from the surplus generated by it, either by way of income earned on investments or capital gains when it books profit on its stocks. Whenever a fund distributes dividend, the NAV will fall to the extent of the dividend. Just because a fund is distributing dividend, it does not mean it is doing very well. Suppose a fund house declares a high dividend, it does not mean exemplary performance .

Usually, a company with a liberal dividend policy may enjoy greater investor interest in the stock market. The same is not applicable to an equity fund. The performance of an equity fund is linked to the growth in value of investments made by the fund.

More funds do not mean diversification of risk, whereas more equity means diversification of risk: Another important point to remember is that investing in more number of funds is not actual diversification. At times, it may reduce your return from investment. Having ownership of several MFs doesn't necessarily diversify your risk. It will be a blunder to buy the same securities over and again in different funds, with different scheme names. You may believe you are diversifying. However, this is not diversification as such. Historically, there are only a few funds which have given consistent performance. However, in case of equities, it is advisable not to put all eggs in one basket. A diversified portfolio of stocks will help you to reduce risk and earn better risk-adjusted returns.

Some important points for investor information

Particulars

Equity funds Equity PriceBased on the price of the underlying securities Based on the demand and supply of the particular stock in the market Transaction CostNo entry Load; but there may be exit load, in case exit is before a specified time periodBrokerage charges and DP charges, as applicable Minimum investmentMinimum investment is usually Rs 2,000 to Rs. 5,000Even one share can be bought Risk diversificationHighLower Performance evaluationReturns v/s BenchmarkNet profit margin(NPM)/ Earnings per share(EPS), Dividend Yield, Price to Book Value Ratio ClassificationClassified based on stocks in which it invests (Diversified, Large cap, Sectoral, Thematic etc.)Classified as per the industry in which it operates (FMCG, Pharma, Diversified, PSU, etc.)

Fund House: Some investors have a notion that investing in an equity scheme of MFs promoted by a large business group like Reliance, Tata, Birla, etc will give better returns. Again, this is not the case, as the performance of the funds depends on the stocks invested and not on the business group that has promoted the fund house. The funds are managed by fund managers appointed by the fund house. The stock selection is done as in the investment objective and fund managers' view on the market.

Conclusion: For those who do not wish to get into the hassle of investing directly in equities, an MF is the best and most preferable route to invest. Investors should understand the differences between equity MF and equity. By doing so, they will be able to take a better and more informed decision.

The author is a freelance writer