Mutual Funds are a great Investment tool and have rewarded Indian Investors handsomely in the last twenty-five years. Mutual Funds suffer from a couple of limitations as mentioned below:
1. The Duplicity of selecting Stocks: When we invest in two Large Cap Funds or any category of Mutual Funds, both the Schemes contain many stocks which are common to both Schemes. This results in multiple exposures to the same Stock. An Index Fund or an ETF eliminates this concern. You should, however, invest in only one carefully selected Index. A carefully selected Mutual Fund does not satisfy the purpose as it does not include all the Stocks from a particular Category.
2. High Portfolio Churn: Mutual Fund are actively managed portfolios. Fund Managers engage in constant purchase and sale of Stocks depending on their perception of how the Stock is likely to perform. This results in high brokerage and other transaction costs which result in high Expense Ratios (Fund Management Fees). Fees The Asset Management Company also hires a full-time Research team which increases Costs of constant surveillance of the Investment Universe without proportionate benefits.
3. High Marketing Costs: Actively managed Mutual Fund Schemes promote themselves by offering commissions to Distributors as a part of their Compensation. This Commission sometimes depends on the amount of business they generate and may not be in sync with the best interests of the investors.
The above factors do not infer that Mutual Funds are a bad investment tool, but these limitations f Mutual Funds can be offset by investing through Index Funds and ETFs. It does not mean that Index Funds and ETFs are protected from any negative aspects. We will cover the limitations of Index Funds and ETFs in a separate story.
