Top 10 Benefits of New Models of Mutual Funds

As more and more people realise that investment needs a lot of prudence, financial services companies are focusing more and more on bringing out new models of mutual funds which are attempting to provide higher returns to potential investors based on their risk exposure. Diversification within the portfolios enable these funds to perform better while mitigating risks. In this article, let us explore how some of these funds are bringing out new benefits for investors.

  1. One of the major benefits for mutual funds is the returns they generate which, even after adjustment of taxes, beats the rates of inflation significantly. Other options for investment like fixed deposits and savings account, actually reduce the purchase value of the investment with the progress of time. This in fact is the main driver for people who invest in mutual funds.
  2. Most of the mutual funds score high in terms of liquidity. One may decide to divest based on needs which may emerge from time to time. Unless the fund is fixed for a time, mutual funds like equity funds have high liquidity, which make them attractive for retail investors.
  3. Systematic and regular investment opportunities are often presented in many new models of mutual funds. Systematic Investment Plans offer lower risk by facilitating small but equal batches of investments, where when the markets are high, smaller number of units are purchased, and when the markets are low, higher number of units are purchased. The process averages out the cost of units purchased to a relatively lower value, thus generating higher returns on the investment.
  4. Closed-end mutual funds facilitate liquidity cre­ation through asset securitization. These mutual funds make it possible for small investors to hold and trade diversified portfolios of securities. Although diversification was not the dominant objective, the trusts provided domestic liquidity in for­eign securities. It opened up possibilities of investment beyond the limitation of economic and geographic barriers directly and indirectly.
  5. Window dressing in mutual funds also started emerging whereby managers make risk pro investment decisions which pay off well if their performance improves. Investors trust these managers for their stock selection ability if the fund performs based on disclosure of proportion of high / low ratio of winning / losing stocks. However sometimes window dressing is attributed to a value destroying activity and is sometimes associated with lower future performances.
  6. Another recent focus is on attention allocation in mutual funds. Normally it is assumed that funds process public or private information about future asset values and use that information to invest in high-valued assets. But formal theories are scarce because information choice models with many assets are difficult to solve as well as difficult to test. This enables investors to seek out investment options that provides potentially higher returns as compared to risk in the long run.
  7. An important area which mutual funds touch upon is taxation reliefs. For example, in India, if some funds have a lock in period exceeding a year, then the profits generated is considered as capitals gain and the appreciation is exempted from taxation. GoI also provides tax rebate for equity linked saving schemes under the section 80C of Income Tax Act 1961. One can invest into these types of mutual funds and deduct upto one and half lakhs from the taxable income to reduce the tax liability.
  8. Further, interestingly, it has been observed that mandatory portfolio disclosure by mutual funds also has a significant impact on stock liquidity and fund performance. Stocks with higher fund ownership, like those which are held by more expert fund managers with higher access to information, experience larger increases in effective liquidity after the regulations change. More informed fund managers outperform others often, especially those holding stocks with greater information asymmetry, and often therefore experience greater performance deterioration after the regulation change. Overall, mandatory disclosure sometimes improves stock liquidity but more often than not imposes costs on highly informed investors, especially in the long run.
  9. Trading costs for mutual funds often become an important parameter in the investment decision making process. Approaches determine mutual fund trading costs using trade-, stock-, and fund-level characteristics. It has been observed that larger trades in smaller valued stocks incur higher transaction costs due to higher control mechanisms which may be required to hedge risks. Interestingly larger funds have lower transaction costs despite their larger trade sizes because they endogenously hold and trade bigger, more liquid stocks but trade less frequently.
  10. Another recent phenomenon is mutual fund activism. It has been seen that firms tie significantly influence pro-management voting at the level of individual pairs of fund families and firms after controlling for Institutional Shareholder Services (ISS) recommendations and holdings. This actually enables a degree of control mechanism on the stake-holders.

Author: Kar

Dr. Kar is in the Information Systems & Management area in one of the top QS Ranked universities of Asia/world. He has extensive experience in teaching, training, consultancy and research in Indian Institutes. He has published over 75 high impact research papers with hundreds of citations as per Google Scholar. He has also authored/edited a number of books. He is the Editor and Founder of Business Fundas.
Note: The articles authored in this blog are his personal views and does not reflect that of his affiliations.