We often read what we like the most. It may be a magazine for someone, a novel or fiction for a few; or it may be just a newspaper for others. Reading becomes interesting when you are reading what you are interested in. But when it comes to reading a rather boring subject (quite a subjective phenomenon; as what is interesting for one person may be boring for the other) it becomes important to have the art of reading ‘between the lines’. Yes, reading between the lines helps a lot as it saves a lot of time of the reader and vital information is also not lost. Especially when the reading material is enormous - for example a mutual fund scheme’s offer document, the tact of reading between the lines helps a lot.

But you should know which areas or portions of the Scheme’s Offer Document or the SID (Scheme Information Document) are important before investing your hard earned money in that particular scheme.

Let’s discuss some of these important areas or portions of the SID in detail:
 

1. Risk Factors: Mutual Funds as you must be aware by now are an indirect route to invest in the capital markets. Thus, the inherent risks of the capital markets are also applicable to the mutual fund schemes as well. Risks such as liquidity risk, settlement risk, default risk, etc., may hamper the value of your investment in the mutual fund scheme. Remember returns in mutual fund schemes are not guaranteed.
   
   Moreover, other than the standard risks mentioned above, there may be some scheme specific risks also. For instance, in an offshore mutual fund scheme, your investments are also exposed to the respective country risks (political and economic risks) where the said scheme will invest. In case of sector specific or thematic mutual fund schemes, the particular mutual fund scheme will be exposed to the developments taking place in that sector; say for instance a mutual fund scheme pertaining to the banking sector will be exposed to the interest rate risks along with the standard risks mentioned above. Hence, it is essential to know the standard risks as well as scheme specific risks which you may be exposed too, before investing.
    
2. The Investment Objective: It is important for you to know the investment objective of the scheme before investing in the same. The investment objective explains the aim behind launching a particular mutual fund scheme and how it will be attained. Apart from this, most importantly it clears the doubt in the minds of the investors created due to the fancy scheme names. For example, ‘Monthly Income Plans (MIPs)’ do not guarantee monthly income as also ‘Capital Protection Oriented Funds’ does not guarantee capital protection, similarly a ‘High Interest Fund’ does not guarantee high interest income. Such ambiguities are clearly answered by the mutual fund scheme’s ‘Investment Objective.’
    
3. Asset allocation: This section of the SID indicates that under normal market conditions the particular mutual fund scheme will adhere to the given asset allocation pattern. The asset allocation pattern indicates the allocation of the mutual fund’s scheme to various asset classes like equity, debt and gold. Typically there is no fixed percentage that is mandated for a particular asset class, instead a range is given. For instance, a range of 65% to 90% for equity asset class indicates that the exposure to the equity asset class should be a minimum of 65% and a maximum of 90% of the total investible amount of the scheme. From the asset allocation provided, you are able to distinguish whether the particular mutual fund scheme is an equity oriented or debt oriented or a hybrid scheme.
   
   The fund manager may shift the equity exposure within the range given, but at any point in time the given range cannot be breached. However, if there is any change in the range of the asset allocation provided then the same is notified publicly. Hence, having knowledge about the asset allocation is imperative before investing in any mutual fund scheme.
    
4. Investment instruments: Suppose the asset allocation pattern of a particular mutual fund scheme indicates the range of 65% to 85% in equity asset class. But within the equity asset class there numerable instruments like stocks, warrants, preference shares, convertible portion of debentures, equity derivatives like futures and options. It is important to know whether the said scheme will have exposure to riskier instruments like derivatives, futures or options as this would weigh on the final returns generated by the mutual fund scheme. However, if a mutual fund scheme takes exposure to derivative instruments purely for hedging their positions then it may not turn out to be of very high risks to investors.
    
5. Investment Strategy: Investment strategy to be followed under a particular mutual fund scheme is one of the most vital information you should understand before investing in that scheme. This particular section of the SID explains the approach to be adopted while selecting different instruments (equity or debt) for investment. The investment strategy reflects the investment processes and systems followed by the fund house as a whole. Such process driven mutual fund schemes are better off than the schemes which are driven by star fund managers.
    
6. Benchmark of the scheme: It is important for you to know the benchmark index followed by the particular mutual fund scheme. Essentially, a benchmark is selected so that the constituents of the same are structured in the portfolio of a respective mutual fund scheme as well. For instance if ‘Mutual Fund A’ has its benchmark as BSE 200, then the equity portfolio of the scheme will structured similar to that of the BSE 200. Hence, knowing the benchmark of the mutual fund scheme will help you to understand the gamut of stock selection oasis available for a respective mutual fund scheme.
    
7. Fund Manager: Even if the mutual fund scheme which you wish to invests in, comes from the stable of a well-established fund house and has proper investment processes and systems in place, it is essential for you to know the fund manager managing your investments in that particular scheme. The fund manager’s expertise is vital for the overall performance of the scheme in the long run. Fund manager’s experience, his or her track record, qualifications, etc. are some of the qualities you should be aware of. An experienced fund manager can make enable creating alpha in case of actively managed mutual fund schemes.
    
8. Fees and Expenses: Your net returns from a particular mutual fund scheme are directly proportional to the fees and expenses charged by the fund house. However, post the entry-load ban by the ‘SEBI’ the impact of the same has minimized a bit but still a higher charges in the form of high expense ratio weighs heavily on the net returns generated by that scheme. Thus, if you have a choice in selecting a mutual fund scheme with similar returns, you should ideally opt for the one with lower expense ratio to boost your net returns.
    

Thus, the next time you wish to invest in a particular mutual fund scheme please make sure that you have read and understood the above important points before investing in that particular scheme, and not merely go by the luring sales pitch of your mutual fund distributor / agent / relationship manager.

 

This article was written exclusively for Equitymaster, India's leading Independent research initiative. Trusted by over a million members all over the world, Equitymaster is known for its well-researched, unbiased and honest opinions on the Indian Stock Market.

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