Rising Sensex, falling NAVs?

FUND QUERIES

My mutual fund investments are mainly in equity schemes. I noticed that when the Sensex moves upwards, many times the NAV of the funds are on the decrease. My basic fear is that the fund manager's fee is eating away potential returns. I see no other reason why the NAV should fall when the Sensex is on a climb. What do you think? Should I continue with my SIP programme or terminate it?

- H.P. Goyal

You are right. An equity fund's net asset value (NAV) may decrease even when the Sensex is on the rise. But you are wrong in assuming that this is the result of a high fund management fee.

There are various charges levied by the fund house. The entry and exit load depend on the period of holding and whether you invest through an agent or not.

Other charges, which include the annual fund management charge (FMC) and recurring expenses, are incorporated in the daily NAV. So if you invest for a period of six months, you bear the charge for six months and not the whole year.

The mutual fund industry in India is extremely well organised, transparent and regulated. Mutual funds are not allowed to retain some profits and transfer the balance to investors (by increasing the NAV). So be assured that the funds are not over charging you and are efficiently declaring their NAVs on the basis of their daily performance.

Now let's get to why the NAV may decline when the Sensex rises. The Sensex comprises 30 large-cap stocks. So a rise in this index does not imply that all listed stocks have risen. The portfolio of the mutual fund may be totally different from the Sensex basket.

It will declare its NAV purely on the basis of the performance of its own stock portfolio on that day. In the recent market crash, there were days when the mid- and small-cap indices crashed despite the Sensex gaining. Naturally, a portfolio laden with mid- and small-cap stocks would see its NAV fall on such days.

Discontinuing the systematic investment plan (SIP) is certainly not advisable. It is perhaps the best way of investing in equity oriented funds. Continue investing and do not worry about these short-term market gyrations.

For the last fiscal year (ended March 31, 2008), I incurred a short-term capital loss on the sale of mutual funds. I will not be able to use the current year's entire short-term loss to offset the capital gains as the short-term losses are higher than the gains. Can I carry forward these short-term losses to offset the capital gains in the future years?

- Ishwar

Yes. According to Section 74 of the Income Tax Act, 1961, you can offset your losses and even carry forward them for eight assessment years immediately succeeding the year in which the loss was first computed.

As per the act, any loss related to a short-term capital asset (like the sale of equity funds/shares within one year), can be set off against income under capital gains in respect of any other capital asset (be it short-term or long-term).

This means, you can even offset this loss against any long-term capital gain. For instance, let's say you invested in a debt fund. After a year, you sell the units and book a profit (long term capital gains). You can offset this gain with your short-term mutual fund investment loss.

I am 61 years old. In a few months' time, I will be getting a substantial sum as a refundable security deposit for my flat in Mumbai. I would need to refund the same after a few years. What is the best and the safest way to invest this amount so that I get 15 per cent return (after tax)? From the gamut of fixed maturity plans, real estate, equity, equity and debt funds, and fixed deposits can you suggest an avenue?

- M Gopal Rao

A post tax return of 15 per cent without any associated risk is too much to ask for. Instead, let's look at the safest options available. Those would be debt funds, fixed maturity plans (FMPs), arbitrage funds and bank fixed deposits (FDs).

FMPs are pure debt funds with a fixed maturity date. Arbitrage funds are those which capitalise on the price difference between the cash and derivatives market.

Going by the past returns, medium-term debt funds have generated an average return of 5.05 per cent (2006) and 7.43 per cent (2007), far below your expectations of 15 per cent. Moreover, these returns are not guaranteed and aren't tax free.

Long-term capital gains are to be taxed at the rate of 10 per cent or 20 per cent (with indexation benefits). You may get a higher and assured rate from a bank deposit, but they will not be as tax efficient as a debt fund or FMP. That is because the gain from a bank deposit is added to income, irrespective of the holding period.

The most tax efficient and safest bet would be arbitrage funds. These funds manage to generate returns similar to any debt fund. But for tax treatment these are considered as equity funds.

Hence there would be no tax liability if you redeem the fund after one year.

The following are few of the well performing arbitrage and medium-term debt funds. As you have a substantial amount to invest, make a portfolio of around 3-4 arbitrage and debt funds.

These would include Arbitrage Funds, Medium-Term Debt Funds, SBI Arbitrage Opportunities, Kotak Flexi Debt, JM Equity & Derivative, ABN Amro Flexi Debt, UTI SPrEAD and ICICI Prudential Long-Term.

Since capital protection is mandatory in your case, it is best you steer clear of equity. As for real estate, the asset is illiquid (not readily convertible to cash) and the sector is extremely sensitive to interest rate fluctuations.

An investor who directly invests in a fund will not be charged an entry load. Can you advise me how can I buy and sell mutual funds online? Moreover, if someone invests in a mutual fund on the day when the stock market falls significantly and sells on the day when stock market rise, can he makes profit out of that?

- Mukesh Mehrotra

Many asset management companies (AMCs) have started offering the facility to transact online via their websites. For this they have tied up with different banks to offer online transfer of funds.

First, you need to ensure that your bank is on the list. Secondly, if you are creating a new folio or investing for the first time with a particular fund house, you would need to send the photocopy of your PAN card (this copy has to be attested by an authorised person).

Once done and your folio is created, you can transact freely on the web to buy or sell funds in your folio. Do note that this procedure is applicable to a single fund house. The whole process is to be repeated while investing in a fund of a different fund house.

As to your second question, it is possible to buy and sell funds whenever you wish to. This can be done similarly as buying or selling shares online.

The only thing you have to adhere to is the cut- off time. Generally, if you successfully transact before 3pm on a particular day, you would get the same day's NAV. After that time, you would be allotted units according to next business day's NAV. To be safe, check the cut-ff time on the company's website before investing.

I have invested Rs 10000 in Franklin India Bluechip Fund for three years. Is it a good fund or not?

- Samar Singh

Franklin Bluechip is a three star rated large cap oriented fund. Of late the fund has been an average performer and there are better funds in which you can invest like Reliance Vision, Sundaram Select Focus or HDFC Top 200.

I have invested Rs 60,000 in LIC Ulip for tax saving under section 80C. How is the fund doing?

One should avoid investing in Ulips as they have high associated charges. All these charges would eat up your returns in the long run.