Are Mutual Funds Adding Value in the Long Term? Diversify Your Portfolio Affordably

Are mutual funds adding value in the Long Term?

The concept of mutual funds was first introduced by NCM Mutual Fund in 1993 A.D. (2050 B.S.) in Nepal. Later on, SEBON came up with Mutual Fund Regulation, 2067 to regulate and facilitate the mutual fund industry in Nepal. The mutual fund industry witnessed significant growth lately and there is a long way for the sector to go. Despite the growth, the sector remains a small player in the Nepalese market. The AUM of the mutual fund in Nepal has been roughly above NPR 3,000 crores for both the open-ended as well as the closed-ended funds.

A mutual fund is a professionally managed collection of funds from both retail and institutional investors. The investments are made in pre-specified financial instruments such as equities, bonds, money market instruments, etc. The fund manager manages and invests the fund collected from the investors while taking reasonable risks supported by adequate research. The competitive advantage of a mutual fund is its capacity to manage its portfolio and risk diversification. Investment in a mutual fund can be quite a convenient way to enter the market for novice investors.

Currently, there is total of 30 closed-end mutual funds and 6 open-ended funds in Nepal, while 6 funds have matured to date. Closed-ended mutual funds have a fixed fund size and pre-determined maturity date. Moreover, closed-ended mutual funds also trade in NEPSE. However, most of the closed-ended mutual funds are traded below around a 5-20% discount on their reported Net Assets Value (NAV). Due to various reasons, mutual funds have not been the first choice of investors and the price has been trading below their Net Assets Value (NAV).

The below chart shows the mutual fund industry’s composite performance since its inception.

Is Price track the actual fund performance?

After the huge market rally back in 2021, the capital market witnessed a significant downside in both the bonds as well as equity markets; which has relatively contributed to the underperformance of these instruments. However, the Mutual fund's NAV has been broadly flattish to slightly negative in comparison with the equity and debt market performance. Most investor compares the fund's performance to its price while giving little or no consideration to the fund's reported NAV. NAV and the market price (LTP) of the closed funds are rarely equal. NAV is the determinant of the fund's actual performance, while the market price of the mutual fund is driven mostly by investor sentiment, market trends, and economic scenarios. Therefore, an investor needs to make a comparison based on the NAV of the fund rather than the Price of the fund. Also, an investor needs to develop a long-term approach to wealth building through the mutual fund to reap the higher possible reward. The below table shows the performance of the assets from the peak to the trough.

Has the mutual fund beaten inflation and the FD rate in long term?

Looking at the last 5 years' data, mutual funds with over 2 years of operation history have been able to comfortably beat the inflation rate and fixed deposit rate of commercial banks. The average annual inflation rate* over the past five years has been ~5.6%, whereas the average annualized return on FD rates* offered by commercial banks over the same period has been ~9.4%. While the average IRR of the NAV of the mutual funds during the same period has ~14.85%. The data supports the claim that investing in mutual funds for the long term can beat both the FD rate of commercial banks and the yearly average inflation rate. Therefore, it would be accurate to state that investing in mutual funds should be a desirable investment option for investors and is becoming more and more popular over time. We can witness higher participation in the equity mutual fund over the next decade or so. The below table shows the historical IRR of the funds with over 2 years of operation history.

Mutual fund investments are a relatively safer way to build investment over the long term. It can be a simple investment vehicle for an amateur investor, who wants to profit from the stock market and eliminate the need to research and decide on a particular scrip for the portfolio on an individual basis. Mutual funds are not completely risk-free, but they do effectively mitigate the unsystematic risk through proper diversification. During the last liquidity-driven bull market, a sizable number of amateur investors entered the market at the wrong time and have been holding an unrealized loss in their portfolio. Mutual funds can be an excellent asset class for investors, who want a superior return in long term and avoid any hassle related to the investment.

Note: Mutual Fund investments are subject to market risks.

*Data are available as of Kartik end 2079.

Article by: Durga Nand Jha, Chief Investment Officer, Prabhu Capital Ltd.