# Mutual Funds - Dog and the bone story

Posted On Monday, Jun 02, 2014

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It is summer time and kids have vacation. It is joy to watch them play. Late afternoon on a Sunday, I watched them play the Dog and the bone. I enjoyed the game during my childhood and even as an adult on family picnics. There are two teams standing in two corners and at the centre is the prize, called the “bone” and one member of each team would come to the centre and try to take away the prize to his team’s corner. “Blink” and the other team could take away the bone. Every trick was used to distract the opposite team member and take away the “bone”.

As my thoughts wandered I realised that in some sense it was a dog and the bone game between the investor and the mutual fund industry. I couldn’t resist comparing this to the mutual fund industry.

"Blink" and as an investor the returns could be eaten away by opaque and unjustified costs. The two tables below illustrates the optical illusion or the distractions used to make the investor "blink"

 Average AUM (INR) 100,000 100,000 100,000 100,000 Gross returns 15% 8% 15% 8% Expense as % of avg. AUM* 3% 3% 1.25% 1.25% Net returns 12% 5% 13.75% 6.75% Gross returns in INR 15,000 8,000 15,000 8,000 Expense in INR 3,000 3,000 1,250 1,250 Net returns in INR 12,000 5,000 13,750 6,750

*Equity mutual fund scheme
^The table used above is for illustrative purposes only

The optical illusion is the expression "expense as % of avg AUM". If this was to be converted and looked at “expense as a % of Gross returns”, then the numbers communicate a stronger message. Even if you win the prize, lot of juice would have already gone.

 Average AUM (INR) 100,000 100,000 100,000 100,000 Gross returns 15% 8% 15% 8% Expense as % of avg. AUM* 3% 3% 1.25% 1.25% Net returns 12% 5% 13.75% 6.75% Gross returns in INR 15,000 8,000 15,000 8,000 Expense in INR 3,000 3,000 1,250 1,250 Net returns in INR 12,000 5,000 13,750 6,750 Expense as % of returns 20% 37.5% 8.33% 15.6%

*Equity mutual fund scheme
^The table used above is for illustrative purposes only

A high expense fund tends to lose a lot of the returns generated. In a year when the returns are modest, the high sort of semi fixed expense eats away a substantial chunk. In the above example it could be as high as 37.5%. I have considered only positive returns scenario. A negative return scenario would be even more devastating.

Sure, there will be some costs and expense, as the asset management industry cannot run without remuneration. However the higher expense ratio needs to be questioned by the investor. Maybe that commission which the mutual fund paid out to your distributor was not worth it. Did he advise you or did he just pick up the forms? Ask your fund and you may get some interesting answers. Maybe it is a better idea for the investor to compensate the distributor rather than the mutual fund.

In the above example only one year was considered. Imagine the impact of such juice being lost over long periods of time. It can make a huge difference to your lifestyle.

At Quantum AMC, we will not increase our current expense ratio of 1.25 per cent (one of the lowest in the industry) for our flagship product - Quantum Long Term Equity Fund# and continue to believe in what is one of the cornerstones of the Quantum Philosophy to offer low cost products while maintaining transparency to our investors.

# Product Labeling
 Name of the Scheme This product is suitable for investors who are seeking* Quantum Long Term Equity Fund (An Open-ended Equity Scheme) • Long term capital appreciation • Investments in equity and equity related securities of    companies in S&P BSE 200 index. • High Risk (BROWN)
* Investors should consult their financial advisers if in doubt about whether the product is suitable for them.
Note: Risk is represented as:
 (BLUE) investors understand that their principal will be at low risk (YELLOW) investors understand that their principal will be at medium risk (BROWN) investors understand that their principal will be at high risk

Disclaimer, Statutory Details & Risk Factors:

Above article is authored by Quantum.

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