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Mutual funds are allowed to use derivative options only to hedge cash positions

LiveMint logoLiveMint 30-08-2017 Srikanth Meenakshi

I am 29 years old and earn around Rs25,000 per month. I want to invest in mutual funds through SIP. I can invest up to Rs2,000 per month for 20 years. Can you suggest what kind of mutual fund should I invest in?

—S. Praveen Kumar

It is good that you are starting your investment portfolio at a young age, and importantly choosing to invest systematically for the long term. For a starting investment, given the amount you are planning to invest every month, a simple balanced fund would meet your needs well.

You can start investing in a fund such as Birla Sunlife Balanced 95 fund. However, please note that this should just be a starter fund for your portfolio.

As years go by and your income grows, you should increase your SIP contribution every month and start investing in a goal-oriented manner (with a definite purpose and fixed timelines).

That would be the proper way to maintain and nurture your investment portfolio. You are beginning well, but you will realize the full benefits that mutual fund investments can bring to your financial life only if you keep growing your investment contributions in a planned manner.

I want to invest in F&O segment through mutual funds. Are there any schemes that invest in it? If so, kindly suggest few schemes. I can invest up to Rs3 lakh lump sum. Is it relatively safer? How should I determine if it is really for me or not?

—Amanda Fernandes

Futures and Options (F&O) are financial instruments that are collectively referred to as ‘derivatives’ since they derive their value from an underlying financial instrument.

Mutual funds are allowed to use derivatives only to the extent of hedging (protecting against losses) of their cash positions.

Hence, mutual funds may not be the ideal option for participating in F&O. If you are merely viewing them as hedging options, then a category of funds called arbitrage funds will suit your needs.

There is also another category of equity funds called equity savings/equity income scheme. These funds partly hedge equity positions and leave the rest unhedged and also take some amount of debt.

That is, they invest in equity, debt, and some derivatives, providing a blended return from these asset classes. Please note that in both of these categories, upside returns will be capped as the hedging restricts full equity participation.

I can invest Rs20,000 per month via SIPs. I am an aggressive investor and want only equity exposure. My goal is to create at least Rs15 lakh by 2021 (50 months). Kindly suggest some schemes to invest in. Also, would I need to increase my investment to achieve this goal? If required, I can increase my SIP investment gradually from next year. Kindly also suggest the percentage increase each year.

—Arnesh Chakraborty

Investment outcomes are a matter of probability, since they are market linked and market movements cannot be predicted with accuracy.

If you invest Rs20,000 a month for 50 months, and if your investments return 18% annually, you will be able to reach your goal of Rs15 lakh at the end of the tenure. An 18% annualized return over the next 4 years is a possible, but not a probable event.

However, if you increase your monthly investment to Rs24,000 a month, even a 10% annual return will get you to your goal.

So, to play it safe, I would suggest that you increase your monthly SIP to as close as possible to Rs24,000 as soon as you can, and improve the likelihood of your reaching your financial target.

Regarding schemes, you can go with a five fund portfolio in the form of a large-cap fund (Aditya Birla Sunlife Frontline equity fund), a couple of diversified funds (Franklin India Prima Plus fund and ICICI Prudential Value Discovery fund), and a couple of mid-cap funds (Mirae Asset Emerging Blue chip fund and Invesco India Midcap fund). This would be, as you desired, a very aggressive, all-equity portfolio.

I would recommend that you watch this portfolio closely as you get near the end of your time frame, and start securing some of the profits in debt or liquid funds to safeguard your gains so that they are available when it’s time.

You have said that if income is erratic then one should take the STP route for investing. But if I move from liquid funds to equity funds, I will attract short-term capital gain. Is that correct because no one discloses that? How does it benefit after paying tax?

—Mayur Sanghavi

Systematic transfer plan (STP) is typically used to systematically deploy sums into equity. If you have a lump sum in hand and wish to deploy in the market, you can invest them using STP by first deploying them in liquid funds.

Yes, every time money is switched out of liquid, there will be a small tax (short-term capital gain) if the liquid fund is under growth option. Since it is a liquid fund, the gain will not be high.

So, the tax incidence is not likely to be high either. More importantly, having the money idling or earning a low interest (also taxable) in a bank account is a worse option compared to paying a small amount of tax by virtue of getting (a likely) higher return from liquid funds.

Srikanth Meenakshi is co-founder and COO, FundsIndia.com.

Queries and views at mintmoney@livemint.com

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