Category Archives: Investing

Interpreting PE Ratios like a pro!

What is the Price-Earning Ratio?

As the name suggests, the Price-to-Earnings Ratio (PE Ratio) is a financial metric that assesses a company’s relative valuation by comparing its current stock price with its Earnings Per Share (EPS). It is calculated by dividing the market price per share by the Earnings Per Share. The PE ratio is a key indicator for investors, providing insights into how much the market is willing to pay for each unit of a company’s earnings. A high P/E ratio may suggest that investors expect high future growth, while a low P/E ratio may indicate lower growth expectations or undervaluation.

Its interpretation can vary across industries, and comparing a company’s P/E ratio to its industry peers or historical averages can provide additional context for evaluation. Additionally, other factors, such as the company’s growth prospects, risk profile, and market conditions, should be considered alongside the P/E ratio for a comprehensive analysis.

Traditionally, the P/E ratio was merely seen as a hard cutoff that was seen as an estimator that would only tell an investor about the relative valuation of a particular company, but nowadays, this estimator is used rigorously to its full potential by considering many other variables, such as the historical trend of P/E ratio, comparing it across Industry P/E ratios and across companies with similar business propositions.

This has resulted in the P/E ratio becoming a much more complex indicator than what it used to be. Today, a high P/E ratio doesn’t necessarily imply that a company is overvalued and has no potential upside, similarly, a lower P/E ratio doesn’t imply that a company is undervalued and has the potential to give high returns.

Modern Interpretation of PE Ratio

In today’s financial world, the Price-to-Earnings (P/E) ratio is looked at in a more detailed way:

  1. Comparison with Peers: Investors check how a company’s P/E ratio compares to similar companies or the overall market. This helps to understand if the stock is priced higher or lower than its counterparts.
  2. Considering Growth: The P/E ratio is assessed alongside a company’s growth prospects. A high P/E can be acceptable if the company is expected to grow a lot in the future, reflecting investor confidence.
  3. Evaluating Risk: P/E ratios are used to gauge risk. A lower P/E may indicate a safer investment, while a higher one might mean higher expectations and higher risk. Investors weigh the potential for growth against the risk.
  4. Market Conditions Matter: P/E ratios are seen in the context of the overall market. In good times, investors may be willing to pay more for earnings, and in tough times, they might prefer more conservative valuations.
  5. Checking Earnings Quality: Investors not only look at reported profits but also consider if the earnings are sustainable, consistent, and from core business operations.

In summary, the modern understanding of P/E ratios involves a more detailed analysis, taking into account a company’s unique situation, growth potential, and overall economic climate. Gone are the days when just by comparing P/E Ratios between two companies, investors could determine whether to buy a stock or sell it.

Challenges and problems faced while using P/E Ratio

The challenges with using Price-to-Earnings (P/E) ratios come from trying to fit a one-size-fits-all approach to companies:

  1. Not All Companies Are the Same: P/E ratios don’t work well for every company or industry. Each business has different growth potential, risks, and financial structures, so applying the same rule to all can give misleading results.
  1. Quality Matters: P/E ratios don’t tell us if a company’s earnings are solid or if they’re just riding a wave. It’s essential to look at where the earnings come from and if they can be sustained.
  2. History Isn’t Everything: Relying too much on how P/E ratios behaved in the past might not be helpful. Economic conditions change, and what worked before might not work the same way in the future.
  3. High Expectations, Not Always Reality: A high P/E might mean people expect the company to grow a lot, but that growth might not happen. Investing solely based on optimistic PE ratios can lead to disappointment and poor Portfolio Construction.
  4. Economic Cycles Matter: Some businesses go through ups and downs with the economy. Ignoring these cycles can give a wrong impression, especially if you look at P/E ratios during extreme highs or lows.
  5. Comparing Apples to Oranges: Different industries naturally have different average PE ratios. Trying to compare them directly might not give an accurate picture. A peculiar example can be that P/E Ratios are very important when considering investing but not so much while trading in stocks.
  6. People’s Feelings Matter: How investors feel about a stock can heavily influence PE ratios. Overconfidence or fear can make ratios too high or too low, causing challenges for investors who rely solely on this measure.

To handle these challenges, smart investors use P/E ratios alongside other measures and consider the bigger picture, like the industry, economy, and other details about a company’s performance.

Overcoming the problems and making full use of PE Ratios

Advantages of P/E Ratios:

  1. Quick Check: P/E ratios give a fast way to see if a stock is priced right, making them handy for a first look. Comparing P/E Ratios for companies in the same industry is a very easy and quick way to grasp the relative valuations of those companies.
  2. Easy Comparison: P/E ratios let you compare different stocks or the whole market, helping spot stocks that might be too cheap or too expensive. It also allows investors to check the market premium paid on global market indices relative to the economic status of the nation.
  3. The feel of the Market: P/E ratios can show if people are feeling positive (P/E going up) or sceptical (P/E going down) about a stock. Increasing P/E ratios indicate a bullish sentiment on the stocks while decreasing P/E ratios in a bullish environment can signal otherwise.

Useful Benchmark: Investors often use P/E ratios to compare a stock’s price now with how it usually behaves or with others in the same industry. P/E Ratios of industries are also compared to analyse and check the relative growth of different sectors in an economy.

Solutions to Challenges:

  1. Mix with Other Ratios: Combine PE ratios with other measures like Price-to-Book or Earnings Growth Rate for a more complete view. P/E Ratios are highly favourable when other factors also indicate a positive outlook, it is less likely that a company will behave according to its P/E Ratio if other ratios are indicating otherwise.
  2. Know the Industry: Understand how different industries work. Some have higher P/E ratios because they’re expected to grow more, while others are more steady. In India, Information Technology (IT) companies enjoy a high P/E Ratio because of their global competitiveness and quality, similarly, the PSU Banks in India do not enjoy P/E Ratios as high as Private Banks because they cater to a different consumer base, despite being in the same industry.
  3. Check Earnings Quality: Look beyond just earnings and think about if the earnings are solid and can keep going. Consider things like where the money is coming from and if it’s reliable. ITC is a company with good financials but the majority of its profits still come from its Tobacco business which is not a good sign for ESG investors.
  4. Think About the Economy: Consider where we are in the economic cycle when looking at P/E ratios. Different industries act differently during good and bad times. During economic booms, P/E Ratios tend to be higher than usual, the contrary happens in times of recessions and Bear Markets.
  5. Think Long-Term: Don’t just look at short-term changes in P/E. See how a company does over a long time and through different economic ups and downs. A steadily growing P/E Ratio over time indicates that the company has good growth potential, and is highly likely that the company is moving positively gaining market share in its industry.
  6. Watch for Feelings: Be aware that how people feel can affect P/E ratios. Keep emotions in check and don’t just follow the crowd. Markets can sometimes severely punish companies that have a negative market perception, this tends to distort PE Ratios and doesn’t give a fair justification for the valuation of the company.
  7. Spread Your Investments: Diversify your investments across different types of assets and industries. This helps balance risk and makes your approach more stable.

By following these tips, you can make the most of P/E ratios while dealing with their challenges, making your investment decisions smarter.

P/E Ratio in Context to Indian Markets

Unlocking Growth Potential in the Indian Markets: A P/E Ratio-Centric Perspective

In the realm of Indian stock markets, the Price-to-Earnings (P/E) ratio takes centre stage, offering investors a crucial lens through which to view market valuations. Despite its nuances, the PE ratio remains a key indicator, and in the context of the NIFTY, its high value may raise eyebrows. However, a deeper dive into this metric reveals a story of optimism and growth prospects inherent in the Indian economy. Yes, the PE ratio is higher than its historical average, but don’t let that set off alarms. In the Indian context, this high ratio is a reflection of the belief in the country’s growth potential.

NIFTY’s High PE Ratio: A Sign of Promise

As of the latest data, the NIFTY 50 index boasts a PE Ratio above its historical average, reflecting the market’s positive outlook on Indian stocks. The NIFTY’s PE Ratio was around 21 on 14th November 2023, signals that investors are willing to pay a premium for each unit of earnings, underlining confidence in the growth trajectory of the Indian economy.

Key Patterns in PE Ratio Trends: Navigating Investment Decisions

Consistent Upward Trend: A sustained upward trend in the NIFTY’s PE ratio might signify ongoing optimism and confidence in the market. However, investors need to evaluate whether this trend aligns with the economic fundamentals supporting such growth.

  1. Sharp Deviations from Historical Norms: Sharp spikes or drops in the PE ratio compared to historical averages demand attention. These anomalies could be triggered by specific events, such as economic reforms, global developments, or corporate earnings surprises.
  2. Correlation with Economic Indicators: A rising PE ratio should ideally align with positive economic indicators, such as GDP growth, corporate profitability, and employment figures. A disconnection between the PE ratio and economic fundamentals may warrant caution.
  3. Sectoral PE Analysis: Instead of a broad market view, dissecting PE ratios at the sectoral level provides a nuanced understanding. Variances in sectoral PE ratios may indicate specific growth drivers or risks within those industries.

Conclusion: P/E Ratios as a Beacon in Dynamic Markets

In the specific context of Indian markets, the P/E ratio serves as a guiding light for investors. Navigating the highs and lows, understanding historical averages, and recognizing significant patterns empower investors to make informed decisions. While the NIFTY’s elevated P/E ratio signals optimism, the key lies in aligning this optimism with the real economic forces propelling India forward.

The P/E Ratio has become a complex instrument for market analysis, which requires depth in the form of other indicators and deep company analysis for it to make concrete predictions. Markets move on emotions and these indicators clearly communicate these emotions to the analysts for research and analysis. As the P/E ratio takes centre stage in the context of Indian markets, its role extends beyond a simple metric to a nuanced instrument for market analysis.

As markets continue to move on the waves of emotions, a comprehensive approach to P/E ratio analysis becomes imperative, offering a clearer understanding of the intricate movements between investor perceptions and market realities.

FAQs

  • What is a good P/E Ratio?
    In the context of Indian Markets, the average P/E of Nifty in the last 20 years was around 20.  So P/Es below 20 may provide good investment opportunities; the lower the P/E below 20, the more attractive the investment potential. However, there is no exact figure for an optimal P/E Ratio for any financial instrument because it is a relative indicator, which is not used in an absolute sense.
  • Can stocks have a negative P/E Ratio?
    A negative P/E ratio means the company has negative earnings or is losing money. Even the most established companies experience down periods, which may be due to environmental factors that are out of the company’s control.
  • Is a low P/E ratio good?
    It is a common perception in the markets that it is better to buy shares in companies with a lower P/E because this means you are paying less for every dollar of earnings that you receive. However, this is not always the case. Companies with structural inefficiencies also have lower P/E Ratios which are not a good indicator of the company’s upside potential.
  • What are the components of the P/E ratio?
    The PE for a stock is computed by dividing the price of a stock (the “P”) by the company’s annual earnings per share (the “E”). If a stock is trading at Rs. 20 per share and its earnings per share are Rs. 1, then the stock has a P/E of 20 (Rs.20/Rs.1).
  • How is the price-to-book (P/B) ratio different from the PE Ratio?
    The price-to-book (P/B) ratio measures the market’s valuation of a company relative to its book value. The market value of equity is typically higher than the book value of a company’s stock. The price-to-book ratio is used by value investors to identify potential investments.

Dividend Yield Fund: Navigating the 101 Investment Guide

In the realm of financial investments, there’s a discreet yet appealing choice for those in search of a consistent income source: dividend yield funds. These investment instruments provide a distinctive opportunity by focusing on stocks that pay out dividends, rendering them a noteworthy element to contemplate for your investment portfolio. In this article, we will dive into the domain of dividend yield funds, examining their advantages, possible pitfalls, and methods for incorporating them into your financial strategies.

What are Dividend Yield Funds?

Dividend yield funds belong to the category of mutual funds or exchange-traded funds (ETFs). They possess a distinct characteristic: a predominant focus on stocks from companies known for their dividend distributions. Dividends represent a portion of a company’s earnings that is routinely disbursed to its shareholders.  have a specific objective — capturing this income for investors by cherry-picking dividend-issuing stocks from a variety of sectors and industries.

The Advantages of Delving into Dividend Yield Funds

  1. Growth Prospects: These funds usually invest in well-established companies with consistent dividend payments. This combination of income generation and growth potential can offer a protective layer against the market’s inherent volatility.
  2. Diversification: These funds typically house a diversified assortment of dividend-distributing stocks. This diversification disperses risk and mitigates the impact of underperforming individual companies.
  3. Reduced Volatility: While no investment vehicle is entirely devoid of risk, These funds typically exhibit lower volatility compared to growth-focused funds, supplying a degree of stability during market tumult.

Key Risks to Consider

  1. Market Volatility: Similar to all equity investments, These funds are not immune to market fluctuations. The value of your investment can oscillate depending on the performance of the underlying stocks.
  2. Interest Rate Fluctuations: A surge in interest rates can render dividend yields less appealing, potentially affecting the fund’s returns.
  3. Company-Specific Hazards: Some companies that pay dividends may decide to reduce or halt these payouts due to financial woes or shifts in their business landscape. Such decisions can impact the fund’s income potential.

Path for Investment in Dividend Yield Funds

Here are actionable steps to consider when incorporating These funds into your investment approach:

  1. Define Your Financial Objectives: Evaluate how dividend income aligns with your financial goals, whether it involves bolstering retirement income or pursuing long-term growth.
  2. Select the Appropriate Fund: Conduct thorough research to single out a dividend yield fund that matches your risk tolerance, investment horizon, and income requisites. Assess factors like the fund’s historical performance, and expense and its sectoral focus.
  3. Diversify Your Portfolio: Even though These funds provide internal diversification, it’s essential to sustain a well-diversified overall portfolio by incorporating other asset categories like bonds or growth-oriented stocks.
  4. Periodically Evaluate Your Holdings: Regularly gauge the performance of your dividend yield fund and modify your portfolio as necessary to keep it aligned with your financial ambitions.
  5. Reinvestment of Dividends: Numerous funds offer the option to reinvest dividends automatically, a practice that can compound your returns over time.
  6. Seek Advice from Financial Experts: If you encounter uncertainty regarding which dividend yield fund suits you best or how to incorporate it into your portfolio effectively, consider seeking personalized advice from a financial expert.

In conclusion

Dividend yield funds offer investors a pathway to receive a dependable income stream while also taking part in the potential growth of established companies. When strategically incorporated into your investment approach, these funds can guide you toward your financial goals in the ever-evolving economic landscape, providing a sense of stability.

FAQs

FAQ 1: What exactly are dividend yield funds?

Answer: Dividend yield funds are investment vehicles, typically mutual funds or ETFs, that focus on acquiring stocks from companies known for paying dividends. These funds aim to generate regular income for investors by selecting dividend-paying stocks across various sectors.

FAQ 2: How do These funds provide income to investors?

Answer: These funds generate income for investors by investing in dividend-paying stocks. These stocks pay a portion of their profits as dividends to shareholders. The funds collect these dividends and distribute them to their investors, creating a consistent income stream.

FAQ 3: What are the potential benefits of investing in These funds?

Answer: Investing in These funds offers several advantages:

  1. Steady Income: These funds provide a reliable source of income, making them attractive for retirees and those seeking regular cash flow.
  2. Potential Growth: They often invest in established companies with growth potential, offering both income and capital appreciation.
  3. Diversification: These funds typically hold a diversified portfolio, spreading risk across various stocks.
  4. Lower Volatility: They tend to be less volatile than growth-focused funds, providing stability during market fluctuations.

FAQ 4: What risks should I be aware of when investing in These funds?

Answer: While These funds offer benefits, they also come with risks:

  1. Market Risk: The value of your investment can fluctuate based on the performance of the underlying stocks.
  2. Interest Rate Risk: Rising interest rates can make dividend yields less attractive, impacting fund returns.
  3. Company-Specific Risks: Some companies may reduce or halt dividend payments due to financial difficulties or changing business conditions, affecting the fund’s income potential.

FAQ 5: How can I get started with investing in These funds?

Answer: To begin investing in These funds, follow these steps:

  1. Define Your Goals: Determine how dividend income aligns with your financial objectives.
  2. Select the Right Fund: Research and choose a dividend yield fund that matches your risk tolerance and investment horizon.
  3. Diversify: Maintain a diversified portfolio by combining These funds with other asset classes.
  4. Monitor Your Investments: Regularly assess the performance of your dividend yield fund and make adjustments as needed.
  5. Consider Professional Advice: If uncertain, seek guidance from a financial advisor to tailor your investment strategy to your unique needs and goals.

 

Gilt Funds: A Comprehensive 101 Guide

In the ever-changing world of money-making opportunities, where finding the right balance between risk and reward can be quite tricky, Gilt funds stand out as an interesting and unique choice. Gilt funds mainly put their money into government bonds, offering investors a mix of safety and potential profits. In this article, we’ll take a close look at gilt funds, exploring what they are, their benefits, possible problems, and how they can be a good fit for various types of investors.

Understanding Gilt Funds

Gilt funds constitute a category of debt mutual funds that predominantly funnel their resources into government securities or treasury bonds issued either by the central government or state governments. These securities bear the distinction of being among the most secure investment avenues, backed by the unswerving creditworthiness of the government, and typically represent a category of low-risk financial instruments.

The Merits of Investing 

  1. Safety: Government securities are among the safest investments because they are supported by the government’s strong financial power. The government can collect taxes and create money, which makes these investments almost risk-free. This makes them a good option for careful investors who want to protect their initial investment.
  2. Steadiness: These funds exhibit a propensity for diminished volatility when compared to their counterparts in the realm of equities or corporate bond funds. They extend a steadfast stream of income, characterized by relatively stable returns across the temporal spectrum.
  3. Diversification: These funds usher in the concept of diversification within the fixed-income asset class. This strategy assuages risk by allocating investments across a mosaic of government bonds, each featuring distinct maturities.
  4. Liquidity: The way these funds are set up allows investors to buy or sell their shares at the current value on any regular business day. This flexibility is especially beneficial for investors who have short-term financial goals or need quick access to their money.
  5. Tax Efficiency: Gilt funds adhere to the 2023 tax amendments related to debt investments. These amendments dictate that capital gains from such investments are incorporated into your applicable tax bracket. We delved into the intricate aspects of debt mutual fund taxation during our podcast episode, stream here.

Risk Profile of the Fund 

While these funds harbor a bevy of advantages, they do not elude exposure to potential risks:

  1. Interest Rate Risk: The value of these funds depends a lot on how interest rates change. When interest rates go up, the prices of bonds usually go down, and the opposite happens when interest rates fall. If interest rates increase a lot, investors could end up losing some of their invested money. We looked into how changes in interest rates affect the debt market thoroughly in one of our podcast episodes.
  2. Inflation Risk: The steady increase in prices, called inflation, can make the value of fixed-income investments, like bonds, decrease in terms of what they can buy. When inflation grows faster than the interest you get from government bonds, the actual returns you earn might turn negative, meaning your money won’t buy as much as it used to.
  3. Reinvestment Risk: As bonds within the portfolio reach maturity, the fund manager must diligently reinvest the resultant proceeds at contemporary interest rates. This presents the peril of lower yields in comparison to the original bond’s offering.
  4. Credit Risk: Although government securities are bedrocked on the premise of minimal risk, a tinge of credit risk persists in terms of the issuer’s capacity to honor its commitments.

Is it for You?

Gilt funds are a suitable investment option for various types of investors:

  1. Cautious Investors: These funds are an excellent choice for people who value safety and preserving their initial investment over trying to make a lot of money.
  2. Income-Oriented Investors: If you prefer a regular and predictable income, you’ll appreciate gilt funds because they provide interest payments from your investments.
  3. Diversification Enthusiasts: For those who like to spread their investments across different types of assets, gilt funds can be an essential part of their strategy. They help reduce risk when mixed with other investments.
  4. Short-Term Aims: Investors harboring short-term financial objectives—be it for the purpose of assembling a down payment for a residence or funding a child’s educational odyssey—can capitalize on the liquidity and constancy proffered by these funds.

Conclusion

Gilt funds offer a unique blend of safety, stability, and moderate profits, making them an important part of an investor’s overall financial plan. While they might not make as much money as riskier investments, they are crucial for safeguarding your initial investment and ensuring you receive a dependable income over time. As with any financial commitment, it is incumbent upon individuals to scrutinize their financial goals, risk tolerance, and investment horizon before venturing into gilt funds. Seeking the counsel of a financial advisor can help facilitate informed investment decisions that harmonize with one’s overarching financial strategy.

FAQs

Q1: What are gilt funds, and how do they work?

Gilt funds are mutual funds that primarily invest in government securities or treasury bonds issued by central or state governments. These funds pool investors’ money to purchase a diversified portfolio of these low-risk government bonds. these funds generate returns primarily through interest income and capital appreciation from changes in bond prices.

Q2: What makes gilt funds a safe investment option?

These funds are considered safe because they invest in government securities, which are backed by the government’s ability to raise funds through taxation and currency issuance. Government bonds are typically considered low-risk, providing a high level of safety for investors’ principal.

Q3: What are the potential risks associated with these funds?

While these funds are relatively safe, they are not entirely risk-free. The primary risks include:

  • Interest Rate Risk: these fund prices are sensitive to changes in interest rates. Rising rates can lead to capital losses.
  • Inflation Risk: If inflation exceeds the yield on government bonds, real returns may be diminished.
  • Reinvestment Risk: When bonds in the portfolio mature, reinvesting at lower prevailing rates may reduce returns.
  • Credit Risk: Though minimal, there is some credit risk associated with the government’s ability to meet its obligations.

Q4: How do these funds generate returns for investors?

These funds generate returns through two main sources:

  • Interest Income: these funds earn interest income from the government securities they hold in their portfolio. This income is typically paid periodically to investors.
  • Capital Appreciation: Changes in bond prices can result in capital appreciation or depreciation. When bond prices rise, these funds benefit from capital gains, and when prices fall, they may incur capital losses.

Q5: Who are these funds suitable for?

These funds are suitable for several types of investors, including:

   – Conservative Investors: Those looking for a low-risk investment option to preserve capital.

   – Income-Seeking Investors: Individuals seeking a stable income stream can benefit from the interest payments provided by these funds.

   – Diversification Enthusiasts: these funds can serve as a diversification tool within a broader investment portfolio, helping to balance risk.

   – Short-Term Goal Planners: Investors with short-term financial goals can utilize these funds due to their liquidity and stability.

 

Navigating the Realm of ESG Funds: A Closer Look at Sustainable Funds 101

In recent times, there has been a notable transformation in the global financial arena, marked by a growing emphasis on investments that embody responsibility and sustainability. Within this landscape, ESG (Environmental, Social, and Governance) funds have gained substantial traction, emerging as a potent instrument for individuals and institutions seeking to harmonize their financial pursuits with their ethical principles. In this blog, we delve into the intriguing realm of ESG funds, unraveling their significance, advantages, and potential influence on both investment portfolios and the world at large.

Unveiling ESG Funds: A Concise Overview

ESG funds, categorized as investment instruments, adopt a unique approach by incorporating environmental, social, and governance aspects alongside conventional financial metrics when assessing potential investment avenues. This distinctive method empowers investors to endorse companies that prioritize sustainable practices, ethical conduct, and responsible leadership. Let’s delve into the three key components:

  1. Environmental: This dimension evaluates a company’s environmental impact, encompassing factors like carbon footprint, resource consumption, waste management, and commitment to renewable energy sources.
  2. Social: Social criteria scrutinize a company’s treatment of its workforce, diversity and inclusivity initiatives, community engagement efforts, and broader societal contributions.
  3. Governance: Governance considerations center on a company’s leadership structure, transparency levels, accountability standards, and adherence to principled business practices.

 

The Merits of ESG Funds

ESG funds offer potential financial benefits, including risk mitigation through better risk management practices, long-term resilience due to sustainable business models, and the potential for enhanced portfolio performance by identifying companies positioned to capitalize on evolving market trends and consumer preferences.

  1. Harmonizing Values: ESG funds empower investors to channel their investments towards causes that resonate with their personal convictions. This alignment often cultivates a profound sense of purpose and gratification in the realm of investing.
  2. Enduring Resilience: Companies that embed ESG principles into their operations tend to exhibit sustained long-term performance. These companies enjoy enduring prosperity by effectively managing risks tied to environmental and social challenges.
  3. Risk Mitigation: ESG analysis equips investors to identify latent risks that traditional financial assessments might overlook. Steering clear of companies with inadequate ESG practices can significantly mitigate exposure to legal, reputational, and financial hazards.
  4. Catalyst for Innovation: Entities committed to sustainability often lead in innovation, adapting adeptly to evolving market dynamics and consumer preferences. Investing in such companies can offer exposure to groundbreaking solutions and technologies.
  5. Positive Influence: ESG fund investments can prompt companies to adopt more ethical practices. The infusion of capital into sustainable enterprises can catalyze far-reaching positive transformations across industries and society.

 

ESG Funds and Portfolio Performance

Contrary to common assumptions, ESG investments need not come at the expense of financial returns. An array of studies has demonstrated that integrating ESG considerations into investment strategies can potentially augment portfolio performance. A comprehensive study by Friede, Busch, and Bassen (2015) synthesized findings from over 2,000 empirical studies, with the majority revealing a favorable connection between ESG aspects and corporate financial performance.

Charting the Path Ahead

As ESG investing garners wider acceptance, the financial landscape is undergoing a paradigm shift in how investment prospects are evaluated. The incorporation of ESG elements into decision-making processes is no longer a niche strategy; it’s steadily evolving into a mainstream practice. Nonetheless, challenges like the standardization of ESG metrics, data reliability, and the phenomenon of greenwashing necessitate a resolution for the sustainable investing movement to attain its full potency.

In Conclusion

ESG funds symbolize a momentous departure from conventional investment paradigms. They furnish a platform to synchronize financial pursuits with ethical values, contribute to positive environmental and societal progress, and potentially attain competitive returns. As the world grapples with increasingly intricate challenges, ESG funds provide an avenue for investors to be part of the solution while pursuing their financial ambitions. The surge of ESG funds signifies more than a mere adjustment in investment strategy, it signifies a broader transition toward a more sustainable and conscientious future.

 

FAQs About ESG Funds

1. What are ESG funds, and how do they differ from traditional investment funds?

ESG funds, also known as Environmental, Social, and Governance funds, are investment vehicles that consider not only traditional financial metrics but also non-financial factors when evaluating potential investments. These non-financial factors include a company’s environmental impact, social practices, and governance policies. Unlike traditional investment funds that solely focus on financial returns, ESG funds integrate these additional criteria to align investments with ethical and sustainable values.

2. How do ESG funds contribute to sustainability and positive change?

ESG funds contribute to sustainability by directing investment capital toward companies that demonstrate responsible practices. By investing in businesses with strong environmental initiatives, positive social impacts, and transparent governance, ESG funds incentivize companies to prioritize sustainability and ethical behavior. This, in turn, encourages positive changes in business operations, promotes innovation in sustainable technologies, and supports community and employee well-being.

3. Do ESG funds sacrifice financial returns for ethical considerations?

Contrary to the misconception that ESG funds lead to lower returns, many studies suggest that integrating ESG factors into investment decisions can potentially enhance portfolio performance. Companies with strong ESG practices are often better equipped to manage risks, adapt to market shifts, and capitalize on emerging opportunities. While individual fund performance may vary, the correlation between ESG factors and positive financial outcomes challenges the notion that ethical investing requires financial sacrifice.

4. How do investors evaluate the ESG performance of companies within these funds?

Investors assess the ESG performance of companies within funds by analyzing various data sources and ESG ratings provided by specialized agencies. These ratings evaluate companies based on specific ESG criteria, allowing investors to gauge a company’s sustainability efforts, social impact, and governance practices. Additionally, companies often disclose their ESG initiatives in annual sustainability reports, providing transparency for investors to make informed decisions.

5. Are ESG funds suitable for all types of investors?

ESG funds cater to a wide range of investors, from individuals with a strong ethical focus to institutional investors seeking to integrate sustainability into their portfolios. These funds come in various forms, such as mutual funds, exchange-traded funds (ETFs), and even customized portfolios managed by wealth managers. However, it’s essential for investors to align their investment objectives, risk tolerance, and values with the specific ESG funds they choose, as the degree of focus on environmental, social, and governance factors can vary.

Explained 101: Low Risk Mutual Funds

Selecting a mutual fund for short-term objectives can pose a challenge, particularly when considering less frequently discussed funds like Low Risk Mutual Funds or Arbitrage Funds! Despite mutual funds having been introduced quite some time ago by investment companies, they have not gained as much popularity as one might expect. In this blog, we will explore the concept of these funds and evaluate whether they are a worthy addition to your capital.

What are Low Risk Mutual Funds?

Investing inherently involves risk, and every financial instrument carries a certain level of uncertainty, including banks that also have a chance of default. To mitigate risk exposure, especially for short-term goals, considering investments in ‘low-risk mutual funds’ can be a prudent choice.

Low risk mutual funds are investment funds that prioritize capital preservation and aim to provide stable returns with minimal exposure to market volatility. These funds primarily invest in debt securities, money market instruments, government bonds, and other fixed-income assets, which are considered less risky than equities or high-risk investments. The objective of low-risk mutual funds is to attract risk-averse investors who seek to grow their wealth steadily without taking significant market-related risks.


Features of Low-Risk Mutual Funds

Why Invest in Low-Risk Mutual FUnds Instead of Index Funds? Let’s Explore the Benefits:

  • Asset Allocation: Index funds closely track a benchmark’s Total Return Index (TRI) and invest primarily in equities, offering a pre mature diversified portfolio. However, for short-term investments, a significant portion of the corpus is allocated to debt instruments and money market-related assets. This strategic asset allocation ensures both diversification and adherence to investment guidelines.
  • Capital Preservation: Inflation can erode the value of money over time, making capital preservation a crucial concern for investors. These funds invest in high-quality assets, prioritizing the safety and security of capital.
  • Capital Appreciation: While the primary goal of any investment is capital appreciation, these funds strike a balance by selecting highly-rated debt and money market assets. This approach ensures a secure investment environment and provides moderate and stable low-risk returns.
  • Lower Volatility: These funds veer away from equities and instead opt for more secure assets like Treasury Bills (T-Bills) with pre-defined coupon rates and maturity dates. As a result, these funds exhibit lower volatility and boast favorable Sharpe ratios.
  • Indexation Benefits: An additional advantage of investing in these financial instruments is their eligibility for indexation benefits. This feature enhances tax efficiency and enables investors to reduce their tax burden.

Factors to consider before investing

Apart from its features, check the following factors on tickertape before investing

  • Yield to Maturity (YTM): YTM is a significant measure for debt funds, representing the anticipated total return on a bond if held until maturity, considering coupon payments and the difference between its purchase price and face value. A low-risk mutual fund with a higher YTM may offer the potential for better returns, but it could also indicate higher credit risk.
  • Interest Rate Risk: Even low-risk funds investing in debt securities are exposed to interest rate risk. When interest rates rise, it can negatively impact bond prices and, consequently, the fund’s Net Asset Value (NAV). Assessing the fund’s sensitivity to interest rate changes helps predict its potential impact on returns.
  • Expense Ratio Components: Delving deeper into the expense ratio involves understanding its components, such as management fees, administrative expenses, and any performance-based fees charged by the fund. An itemized breakdown of expenses helps assess the fund’s operational efficiency.
  • Duration Gap and Convexity: For investors concerned about interest rate risk, it’s essential to evaluate the duration gap (difference between fund duration and portfolio duration) and convexity (bond price sensitivity to changes in yield). These factors provide additional insights into the fund’s risk profile.
  • Sharpe Ratio and Standard Deviation: Considering the Sharpe ratio and standard deviation helps assess the fund’s risk-adjusted performance and volatility. A higher Sharpe ratio indicates better risk-adjusted returns, while a lower standard deviation suggests more stable returns, which align with the low-risk nature of the fund.

Who should consider it worth investing in?

Low-risk mutual funds are well-suited for investors displaying the following characteristics:

  • Risk-Averse Investors: These are individuals who prioritize preserving their capital over seeking high returns and are uncomfortable with the significant fluctuations commonly associated with the stock market. For such cautious investors, low-risk mutual funds provide a secure avenue to grow their wealth steadily without subjecting their investments to high market volatility.
  • Short to Medium-Term Financial Goals: Investors with short to medium-term financial objectives, such as saving for a down payment on a house, funding education expenses, or planning a vacation, may find low-risk mutual funds to be the appropriate choice. By focusing on stable, fixed-income assets, these funds offer more consistency and reliability compared to equity funds, making them a practical option for meeting short to medium-term milestones.
  • Conservative Investors: Conservative investors, particularly retirees or those nearing retirement age, have a strong preference for stable income and aim to protect the wealth they have accumulated over the years. Low-risk mutual funds align well with the risk-averse nature of these individuals, providing them with a reliable source of steady income and an opportunity to grow their savings prudently without being exposed to significant market risks.
  • First-Time Investors: For beginners stepping into the world of investments, low-risk mutual funds serve as an excellent starting point. As they embark on their investment journey, first-time investors often seek safer options that offer some degree of predictability. Low-risk funds provide a gradual introduction to the investment landscape while allowing investors to learn about market dynamics without undue anxiety over market fluctuations.

So, what did you decide?
Contact a mutual fund advisor like Daulat, and make an informed decision.

5 reasons why Hybrid Mutual Funds are best for diversification

Diversification is a crucial part of financial planning and, investing in mutual funds provides individuals with an opportunity to grow their wealth while diversifying their investment portfolios. But, building mutual funds portfolio can be a tedious job, finding the right mutual funds for equity and debt investment, tracking them, and bearing other chargers such as expense ratio and exit load simultaneously.

That’s where “Hybrid Mutual Funds” bridge the gap for investors prevailing against the barriers of sorting two funds and bearing their individual charges. Hybrid mutual funds, also known as balanced funds, offer a unique combination of asset classes, combining the benefits of equity and debt instruments. In this blog post, we will delve into the world of hybrid mutual funds, uncovering their advantages, considerations, and why they are worth considering for your investment strategy.

What are Hybrid Mutual Funds?

Mutual fund houses came up with a balanced mutual fund, with the aim of providing investors with diversification options under one fund. These funds aim to provide a balance between capital appreciation and income generation while managing risk through diversification. Here are the key features of hybrid mutual funds:

Hybrid funds, allot their corpus across different asset classes, provident the much-needed balance against the volatile market. One asset class balances out the turmoil of its counterpart. These funds typically, allot around 80% of their corpus in equity, 15% in debt, and the remaining 5% in cash equivalent and other alternative investment options.

  • Capital Appreciation and Stability: 

The equity component of the funds assures capital appreciation, as their underlined stocks appreciate in the market. The debt component of the funds includes corporate bonds, government securities and other debt instruments. The debt component provides stability, and regular income generation, and acts as a cushion during market downturns. The allocation to debt instruments helps manage risk and reduces the overall volatility of the fund.

Hybrid funds offer diversification by investing in a mix of equity and debt instruments. This diversification helps spread risk across multiple asset classes, sectors, and securities. By diversifying the portfolio, hybrid funds aim to reduce the impact of a specific security’s performance or market volatility on the overall fund’s returns.

  • Regular Income: 

Dividends from the equity component and Interest yields from the debt component assure a regular stream of income for the investors. But, generally, these dividends and interest yields are re-invested in the funds, resulting in an overall value increase for the funds.

Points of consideration before investing

There are several points of consideration before investing in any asset class, analyzing and examining across various checkpoints. All these points are to be compared for each point against the industry average. Following are some points of consideration for hybrid mutual funds:

  • Expense Ratio: The expense ratio represents the annual fees and expenses charged by the mutual fund for managing the fund’s assets. A lower expense ratio indicates the fund is comaparitevly cheaper and will have a positive impact on the overall performance of the investment.
  • Sharpe Ratio: The Sharpe ratio measures the risk-adjusted returns of a mutual fund. It’s beneficial to consider the Sharpe ratio when comparing different hybrid funds as it provides insights into how well the fund has performed relative to the level of risk taken. A higher Sharpe ratio indicates better risk-adjusted performance.
  • Exit Load: Exit load refers to the charges, an investor has to bear while redeeming his investment returns if sold before a specific time period generally during the lock-in period. Exit load affects the liquidity and flexibility of the investment. 
  • Minimum Investment: The minimum investment requirement specifies the minimum amount of money that an investor must contribute to purchase shares of a mutual fund. It’s essential to consider the minimum investment required to ensure that it aligns with your investment capacity and financial goals. Some funds may have higher minimum investment amounts, which may only be suitable for some investors.
  • Funds’ Objective and  Asset Allocation: Hybrid funds are divided into three categories based on objective and asset allocation:
    • Conservative: The debt Component is more than that of the equity component.
    • Moderate: Allocation is balanced between equity and debt component.
    • Aggressive: Mojoirty of the corpus is invested in the equity component.

Each category yields different returns and carries its own risk. Aggressive carries the most whereas conservative carries the least. Investors can choose funds based on their goals and risk tolerance. Which can be decided based on the rules of investing.

India’s top performing Hybrid Funds**

Fund NameAMCReturns (3 years)Returns (5 years)
ICICI Prudential Equity Savings FundICICI Prudential11.45%8.17%
HDFC Hybrid Equity FundHDFC25.00%12.73%
Kotak Mahindra Focused Equity FundKotak Mahindra25.76%16.88%
SBI Multi Asset Allocation FundSBI13.90%10.75%
Nippon India Growth FundNippon India35.57%16.97%

**It is advisable to conduct thorough research and contact your mutual fund advisor, before investing.

To Sum it UP

Hybrid mutual funds offer a range of benefits, including diversification, balanced risk, and return, risk management, potential income generation, flexibility, and a simplified investment approach. However, investors should carefully consider the risk profile, market volatility, fund management, expense ratio, investment horizon, and tax implications before investing in hybrid funds. By conducting thorough research, consulting with financial advisors, and aligning the funds with their investment strategy and risk tolerance, investors can make informed decisions about incorporating hybrid funds into their investment portfolios.

 

5 steps to take before you start your financial journey

Most investors face a constant dilemma when they think about investing in equities. One of the primary questions in their minds is – How do I start my financial journey? Am I ready to start investing?

A straightforward answer to this question is that start your financial journey today since there is no ideal time to start investing. As Warren Buffett says, “Investing is about TIME in the market and not TIMING the market.”. But one thing that people can do before starting their investment journey is to prepare well. In this article, we will go over 5 steps one can take before they start investing to make the process much easier.

Draw a personal financial journey roadmap

Before you make any investments of any sort, sit down and take an honest look at your entire financial situation — especially if you’ve never made a financial plan before.

The first step to successful investing and capital gains is figuring out your goals, either on your own or with the help of your family. Once this goal is set, investment plans can be designed to specifically meet these goals as soon as possible. There is no guarantee that you’ll make money from your investments. But if you understand how investing works and follow through with a well-designed plan made by either you or your financial advisor, you should be able to gain financial security over the years and enjoy the benefits of good investing.

Understand your comfort zone

Any form of investment carries risks. In fact, investment risks somewhat tend to be directly proportional to their potential returns. Hence, higher risks imply higher potential returns and vice versa. While every investor desires to earn high returns, taking high risks might not be suitable for all of them. If you invest in an instrument that has a higher risk than what you are comfortable with, then you might make rash decisions and suffer losses.

On the other hand, if you invest in instruments with much lower risks than your tolerance levels, then you might not be satisfied with the return and might not be able to meet your financial goals. Therefore, it is important to understand your risk tolerance levels and tie them with your return expectations to create an investment strategy to meet your financial goals at a suitable time.

Learn, Learn and Learn

The most important thing one needs to do before making an investment of any sort is to learn how it works and gain a deep understanding of it. You must spend some time understanding investments, markets, factors that affect prices, things that you need to know to analyze a company, etc. Insufficient knowledge of investment opportunities can cause a person to make uninformed decisions that can cause huge losses. By learning how investments work, one can make better decisions and stay informed of how their portfolio is doing. You will make mistakes but learn from them and don’t make the same mistake twice.

Staying in touch with the news, reading financial books and understanding yourself and the reason why want to invest are a few ways that can help you make informed decisions.

Understand your time horizon

A very important aspect that you need to identify is the time in which you intend to stay invested. This will depend upon 2 factors: your financial goal and your risk appetite. For example, If you are investing to build a retirement corpus for yourself, then your investment period would be longer than investing in buying a house. This is essential since different types of investments can have different investment period requirements and growth rates. One should ideally stay invested, till their goals are met.

Investments are generally broken down into two main categories: Risky and less risky. The longer the time horizon, the more aggressive, or riskier, a portfolio an investor can build. The shorter the time horizon, the more conservative, or less risky, the portfolio the investor may want to adopt. This is because equity markets are generally volatile in the short term and there is a possibility that you can get caught in a bear market thereby causing interim losses to your portfolio.

Create a well-diversified investment plan

By including asset categories with investment returns that can either move up or down pertaining to different market conditions within a portfolio, an investor can help protect against significant losses.  Historically speaking, the returns of the three major asset categories – stocks, bonds, and cash – have not moved up and down at the same time at any given point.  Market conditions that can cause one asset category to do well often cause another asset category to have average or poor returns.

By investing in more than one asset category, you’ll reduce the risk of losing your money and your portfolio’s overall investment returns will have a smoother and gradual rise.  If one asset category’s investment return falls, you’ll be in a position to counteract your losses in that asset category with better investment returns in another asset category which can help you stay in the green. For e.g. It is often seen that international markets like the U.S., and Europe are lowly correlated with the Indian equity markets and hence a small allocation to overseas investments can greatly help in diversification.

In addition, asset allocation is important because it plays a major role in whether you will meet your financial goal.  If you don’t include enough risk in your portfolio, your investments may not earn a large enough return to meet your financial goal.  For example, if you are saving for a long-term goal, such as retirement, most financial experts agree that you will likely need to include at least some stock or stock mutual funds in your portfolio for a good return on investment.

Bear Markets and investing – 4 things to do to protect your money!

We all worry about our money. It is quite easy to understand why one would be worried about having little or no money. But, we also worry when we do have money. This is especially true if our money is invested in equities and the stock market is in the middle of a bear market. Therefore it is important to follow some basic steps to stay financially fit.

In this article, we will go over 4 steps one can take to not only safeguard their money from a bear market but also grow their money simultaneously.

Don’t panic sell

During market corrections, selling off your investments and timing the market might seem like a good idea. Negative news such as the Covid-19 pandemic, an asset bubble that’s about to burst, financial scams being revealed, etc., can easily influence any investor.

However, past data shows that the best and worst-performing days of the stock market are often very close to each other. This is the key reason why the strategy of timing the market does not work well for a lot of long-term investors. The key thing to remember is that fear leads to panic, especially among novice investors. This panic often makes investor sell their positions at low prices during a bear market.

But historically, markets have always recovered from these bearish trends and instead of selling in a panic, you should just remain calm and stay invested. If you manage to continue investing irrespective of market conditions, you will reap the rewards when the markets recover at a later date.

Don’t panic buy

Panic buying can be described as a state of mind that pushes you to make investments without much deliberation or research, which can become an obstacle to reaching your current investment goals.

After all, when markets are down, it often seems to be a great time to invest at reasonable valuations. In such cases, investors often part their money in Bluechip stocks or purchase Index Funds. However, many investors forget one key aspect of Equity/stock investing in such cases – their own risk appetite. The buying frenzy when markets tank can lead investors to invest in Equities which are not aligned with their actual risk appetite.

So instead of panic buying, you should plan for these investments well before the bear market actually starts. But to do this, you need to know how high or low your personal risk tolerance is. Only then will you be able to accurately decide how much of your existing portfolio needs to be rebalanced to meet your goals

Periodically rebalance your portfolio

Portfolio rebalancing is a strategy that helps in aligning your risk appetite to your investment portfolio so as to provide better risk-adjusted returns on your investments. This strategy involves buying and selling equities and investments periodically so that the weight of each asset class is maintained as per your targeted allocation.

Some key questions that one needs to ask themselves when assessing their current investments and deciding if their portfolio needs rebalancing :

  • What am I invested in – Mutual Funds, Stocks, Bonds, Gold, etc?
  • What is the value of my investments?
  • What are my financial goals?
  • What do I focus on when building my investment portfolio – consistent returns, growth of capital, etc?

If done right, rebalancing your portfolio will not only help you stay on course to reach your financial goals but also help you manage overall portfolio risk and safeguard your money when markets are highly volatile. That said, it might not be a good idea to rebalance your portfolio in the middle of a bear market. You should instead consider letting markets settle down a bit before rebalancing your investment portfolio.

Choose your equities carefully

An ongoing bear market provides you with the perfect opportunity to increase your Equity allocation at a very reasonable cost and allows you to switch to a more aggressively approached asset allocation portfolio from a comparatively conservative allocation. This is because Equity investments, especially when purchased at low valuations, have an unmatched ability to boost your investment returns, which can help you meet long-term goals such as retirement.

So, if you plan to make Equity investments during a market correction, make sure you do adequate research on the equities you look to invest in. But, if you do not know how to correctly value stocks or don’t have the time to conduct a deep dive into possible investment options, it might be a better idea to invest in professionally managed diversified Equity Mutual Funds as compared to investing in individual stocks on your own.

Bottom Line

An ongoing bear market offers investors a unique opportunity to grow their wealth. But to take advantage of this crash, you must have a contingency plan in place before the crash actually happens. The 4 strategies discussed above are designed to help you not only weather a market crash better but also make sure that you can grow your wealth significantly when markets recover at a later date.

7 timeless lessons for novice investors

Understanding where to invest and earning considerable profits can be daunting and also requires a learning curve. In this article, we go over 7 lessons that will help novice investors to not only invest better and maximize profits, but also help you minimize your losses.

Lesson 1 : Diversification is key

One major mistake that novice investors make when they start their journey is that they concentrate their assets in a single form of investment. Diversification not only means investing in different stocks or investing in a single industry but also the allocation of assets in different asset classes such as, equities, mutual funds, bonds, real estate, etc. But it is also important to understand that too much diversification is also a problem because investing in multiple assets with a limited asset pool will not allow you too reap significant rewards.

Diversification for novice investors

Lesson 2 : Keep your emotions in check

Investing your hard earned money is a rather stressful process for not only novice investors but all investors which can lead to you trusting your emotions rather than your mind and emotionally invest. Emotional investing is an investing strategy where you make decisions based on markets’ daily gyrations and what you think of them rather than fundamentals. It constitutes of letting fear, greed, anxiety, and optimism get the better of you. This type of investment is based on an investor’s behavioural and emotional impulses and is influenced by market trends. It is more of a cycle where investors react to market volatility and swings.

Lesson 3 : Consult a financial advisor

Engage with a financial advisor to better understand your situation and help you invest better. Expert advice can do wonders to a novice investor’s portfolio and help them see the big pictures. Financial advisors, who have years of experience, can help you navigate choppy waters and bullish markets with ease and ensure you do not indulge in impulsive trading or overestimate your risk tolerance.

It gives you the chance to re-evaluate your investment approach and better assess your risk appetite. It helps you be logical and make rational investment decisions to help your money grow.

Lesson 4 : Educate yourself financially

Financial literacy is a crucial life skill to possess, because it boosts your financial capability. Savings, budgeting, and financial planning should be taught to people at a young age. Without financial literacy, one’s actions and decisions about savings and investments would be quite weak and unsupported. One can manage their finances effectively by learning basic financial principles. Additionally, it facilitates good financial decision-making, financial management, and stability.

Lesson 5 : Avoid trying to time the market

The time you spend in the market is much more important than timing the market. Moreover, it is important for novice investors not to develop a trader or speculator’s mentality right of the bat. After all, this entire practice of timing the market based on news, opinions, tweets, interest rates, liquidity, and so on often does a lot more harm than simple rules based investments focusing fundamentals.

If you have not reached your long-term financial goal then canceling your SIPs and liquidating your assets is certainly not going to help you reach there any faster. Stay invested for the long game, as stock markets and individual stocks have reliable businesses behind them that are continually earning more and more profits over the long run.

Lesson 6 : Have a goal in mind

Goal based investing involves keeping a specific personal goal in mind while choosing the method to invest. Goals help investors stay on the course and keep investors disciplined as they can monitor and track their progress at regular intervals. A set of clear goals helps strategize and dramatically improve budgeting. As a result, investors deal with poor market movements better. Focusing on long-term goals, allows us to be less distracted by short-term volatility and noise.

This is a crucial advantage because not only do novice investors sometimes lose hope, but emotions can also drive them towards poor decisions. It will help us refrain from selling down our positions or changing our investment strategy to one that reduces our chances of reaching our financial goals, and instead focus on sticking to our designed investment plans.

Lesson 7 : Invest in companies with good fundamentals

Fundamentals of a company are usually its indexes, which are used to determine its financials and whether the investment price is able to justify itself through earnings and profit. Investments that are able to justify their price are called value investments.

Value investing involves a process through which investors unearth possible investment opportunities that are available at a lower price of what they’re actually worth. These investments are known as undervalued investments and they generally tend to possess a significantly high growth potential in the future. Value investments have very little downsides to them, a good example to explain this is stocks. With value stocks, the downside, if any, also tends to be lower since they’re already trading at a lower price point than their actual worth.

Side-pocketing and segregation

In recent times, the Mutual Fund industry has witnessed a series of downgrades and defaults. Starting from the IL&FS, Essel, DHFL to Franklin, Birla and nippon. These downgrades or defaults can cause huge losses for investors who have parked their life-savings into these funds. Thus to protect investors from these defaults, SEBI announced the launch of the side-pocketing or segregation framework.

Many beginner to intermediate investors are unfamiliar of the concept of side-pocketing and how it can affect them, which makes it even more important for them to understand this very concept.

What is Side-Pocketing in Mutual Funds or Segregation of the Portfolio?

Simply put, side-pocketing is a framework that grants mutual funds the power to segregate the bad assets in a separate portfolio within their debt schemes. The Securities and Exchange Board of India (SEBI) introduced this very framework in December 2018 — primarily triggered by the IL&FS fiasco. The side pocketing framework was launched by SEBI so that the existing investor in the scheme may get the benefit whenever the money recovers. This is also to discourage the new investors from entering the scheme after the event, so as to not take undue advantages of the situation.

When does side-pocketing occur?

As per SEBI regulations, side-pocketing in mutual funds can be done only when there is an actual default of either the interest or principal amount of investment or if a debt instrument is downgraded to below investment grade or BBB rating by credit rating agencies, then the fund house has the option to create a side pocket and segregate their funds.

When side pocketing in mutual funds is done, the fund house is not sure whether the security would be realizing something later or not, but the net asset value of the fund is reduced with immediate effect.

Side-pocketing

So, in this scenario, the existing investors of the fund are allotted an equal number of shares in the segregated portfolio as held in the main portfolio and no redemption or purchase is allowed in the segregated portfolio. These shares are then listed on the stock market within 10 days and investors can sell them within a 30 day window, without any exit load/fee.

How does side-pocketing benefit the retail investor?

Once the shares of the segregated fund are listed on to the stock market and are ready to be sold, it gives full autonomy to the investor and lets them do whatever seems fit to them. Effectively, this process makes the price discovery of the bad assets a transparent procedure with investors having the freedom of either selling it at prevailing price or holding it if they expect the value to recover in future.

Can side-pocketing be misused?

When side pocketing was introduced, a good chunk of market participants felt that it could be misused by fund houses to hide their bad investment decisions. SEBI, however, has put in place checks and balances to minimize any such malpractice by the fund houses. The regulator has said that trustees or higher echelon of all fund houses will have to put in place a framework that would negatively impact the performance incentives of fund managers or chief investment officers (CIOs) or any stakeholders involved in the investment process of securities under the segregated portfolio.

So, fund managers know that any creation of such side pocket in the future would also affect their own appraisals and incentives. Further, SEBI has also said that side pocket should not be looked upon as a sign of encouraging unwanted credit risks as any misuse of this option would be considered serious and stringent action can be taken.

In Conclusion

Side-pocketing in mutual funds or Segregation of the Portfolio is a quite beneficial approach for the retail investors who lose their hard-earned money due to unwanted defaults in the debt funds. And it is quite logical that those who actually lose should only get the benefit of recovery too, and no other person should be allowed to make use of the situation as it used to happen earlier.