Numerous resources can be found on the internet that give us an idea about what Mutual Funds are and why investing in them can be advantageous or disadvantageous. Thus, this article[D1] does not intend to dive deep into explaining the fundamentals of Mutual Funds. Although this writeup does touch upon the basics of Mutual Funds briefly, what it really aims to focus on is why now is a good time to start making Mutual Funds part of one’s overall investment portfolio.
What are Mutual Funds?
Mutual Funds are basically professionally managed investment funds that pool money from investors to invest in a diverse range of investment instruments. In Nepal, these funds are allowed to invest in securities listed with the Securities Board of Nepal (SEBON), IPOs/ FPOs, securities listed in NEPSE, bonds, debentures, money market instruments, bank deposits, and other areas specified by SEBON through its Mutual Fund Regulations 2067.
There are currently 20 Mutual[D2] Fund schemes available in the market, including two Open-Ended Mutual Funds, with several new schemes in the pipeline.[1] Close-Ended Mutual Funds issue a fixed number of units for fixed periods of about 5-10 years. These funds are listed in stock exchange and can be subscribed through IPOs, or they can be purchased in the secondary market. An investor can get returns in forms of dividends, capital gain by selling them in the secondary market, or by holding the units until maturity to receive the NAV amount. On the other hand, Open-Ended Mutual Funds are not listed in the Stock Exchange nor do they have a maturity date. They can be bought from or sold to the fund managers at any time, at prices based on their NAVs. The value of a Mutual Fund or its Net Asset Value (NAV) is calculated by subtracting its liabilities (expenses) from its assets (Value of its investments and Bank balances) divided by the total number of units.
What advantages do Mutual Funds have in general?
For new investors with little market knowledge wanting to test the waters, small investors with limited funds, or for investors who have limited time or skills to actively trade in the market, Mutual Funds usually are good investment vehicles. Mutual Funds are legally required to diversify their investments, which not only include stocks, but also bonds, debentures, government securities, fixed deposits and other areas allowed by SEBON. So, investors get to be part of a diverse portfolio without having to purchase each security individually. Plus, these funds are managed by professionals with years of experience in the capital market, meaning they are probably better at making investment decisions that the average investor. Unlike shares of companies which have a par value of NPR 100, Mutual Funds have a par value of NPR 10, making them extremely affordable. As a result, investors gain good amounts of returns while minimizing risks at affordable costs. Furthermore, investors can also liquidate their investments in Mutual Funds any time they wish to, as mentioned previously.
Although Mutual Funds are not a new concept in Nepal and have been around for over two decades, interest of investors towards these professionally managed funds has been quite low. It actually is not that surprising, as buying Mutual Funds usually gives lower returns compared to trading stocks in general. Although the risk of investing in a Mutual Fund is much lower than the risk of trading stocks in the secondary market, the latter does provide investors with higher returns in short periods (if you trade wisely or in a bullish market). If you are an experienced trader with good knowledge of the market, good analytical skills, a hefty pocket, and the stomach to tolerate risk, you may be better off trading stocks.
Nevertheless, let’s get into the main agenda of this writeup and talk about why it is probably a good decision to include Mutual Funds in one’s portfolio, especially in the current context of Nepal’s capital market.
Rise in number of Investors
Compared to just a year ago, the number of investors in the Nepalese stock market has grown exponentially. Data from the CDS and Clearing Ltd. shows that over 3.72 million Demat accounts have been registered as of April 4, 2021.[2] Just recently, 1,804,648 applicants applied for the IPO of Jyoti Life Insurance Company, out of which only 5,94,000 applicants (around 33%) were allotted 10 shares each[D3] .[3] It is certain that one’s chances of getting allotted shares in IPOs will only go down as the number of investors increase. On the contrary, 5% of the total IPO issued by any company is guaranteed for Mutual Funds. Therefore, it might be advantageous for small investors to hold on these funds as well, whether they are allotted the company’s shares or not.
Tax Benefits
In Nepal, like in many countries, investors are provided tax exemptions for investing in Mutual Funds. While normal investors are taxed on the dividends received from stocks, capital gain, as well as on interest received on bank deposits or bonds, Mutual Fund investors are exempt from paying any kind of taxes associated with the fund. This includes taxes on dividends paid by the fund, capital gain on sale of units, or on NAV received at the end of the maturity period. Investors in India can claim tax deductions of up to INR 150,000 on their investment in Mutual Funds like the Equity Linked Savings Schemes (ELSS).[4] In the future, such provisions also might be implemented in Nepal.
Difference in NAV and LTP
The NAV represents the actual performance of the Mutual Fund while the Last Traded Price (LTP) represents how investors’ perception or sentiments towards the security. A comparison between the latest NAVs of the available Mutual Funds and the LTP of these funds shows that the Mutual Funds are largely undervalued. They are being traded at a discount of up to 28%. The Global IME Samunnat Scheme 1 (GIMES1), which currently has the highest monthly NAV of NPR 19.27 had an LTP of NPR 15.97 i.e., a discount of 20.19[D4] %.[5] In the current scenario of a bullish market, increasing number of new investors, and short supply of stocks, the NAV of Mutual Funds would probably go further up as well.
Book Building
One of the main reasons why buying Mutual Funds in the current scenario would be a good decision is the introduction of the Book-Building process in the Nepalese capital market. The Book-Building process allows companies to issue IPOs at premium prices. It is argued that this process favours institutional investors and large buyers more, as small retail investors may lack the financial capacity to invest in stocks under the book-building method. Retail investors are required to apply for a minimum of 50 shares at a discount of 10% on the cut-off price, which might discourage small investors from participating. This would not be a big deal for Mutual Funds, as they have the resources required to purchase and analyze these stocks. Also, let’s not forget that Mutual Funds are guaranteed 5% of the total shares of each IPO issued. With limited number of investors holding the majority of these stocks, we can assume that their value would be pushed up. Subsequently, the NAVs of Mutual Funds too would go up.
Conclusion
As mentioned
previously, if you are an experienced trader with large funds available and have
a high tolerance of risk, Mutual Funds might be the least bit interesting. But,
for small investors and new investors lacking enough knowledge, financial
capacity, and risk tolerance, and due to all the reasons mentioned above, making
Mutual Funds part of your portfolio would definitely be worth it. Nevertheless,
Mutual Funds are not 100% immune to market risks, as movements in the market
heavily depends on the sentiments and emotions of investors.
[1] Roberto Eldrum.” 20 Mutual Funds You Can Buy in Nepal”, Tough Nickel. January 22, 2021. Retrieved from: https://toughnickel.com/personal-finance/Mutual-Funds-in-Nepal
[2] CDS and Clearing Limited. April 4, 2021. Retrieved from: https://cdsc.com.np/
[3] Share Sansar. March 26, 2021. Retrieved from: https://www.sharesansar.com/newsdetail/ipo-allotment-of-jyoti-life-insurance-concludes-lucky-investors-get-10-units-each-and-remaining-509047-applicants-return-empty-hands-2021-03-26
[4] The Economic Times, “Do all mutual funds qualify for tax benefits under Section 80C?”, The Economic Times. February 23, 2021. Retrieved from: https://economictimes.indiatimes.com/mf/analysis/do-all-mutual-funds-qualify-for-tax-benefits-under-section-80c/articleshow/71536788.cms?from=mdr#:~:text=Investors%20can%20claim%20tax%20deduction,tax%20deduction%20under%20Section%2080C.&text=That%20means%20you%20can%20invest,under%20Section%2080CCD(1B).
[5] Share Sansar. April 4, 2021. Retrieved from: https://www.sharesansar.com/mutual-fund-navs
Thumbnail Picture Source: https://fififinance.com/us/mutual-funds
