Beware of the weapons of mutual fund mis-selling

“I made a couple of amazing investments today”, announced Nikhil. His voice was brimming with excitement.

Nikhil and I had recently become friends.

“OK. And what are those?” I was curious.

“I have applied to this new fund offer of Select micro cap series N. The fund house is known for its stock picking skills in this category. In this new fund too, they will pick the best of the micro sized companies. In fact, the past returns of such offers has been in the 30s.”

It looks like Nikhil was sold big time on this new fund. He himself was sounding like a fund salesman. “Is this a closed ended fund, I mean is there a lock in?” I queried.

“Yes, 5 year lock-in. But that is OK. Micro caps need that much time.” This was further proof. The AMC should actually consider hiring him.

“Who told you about this fund?”

“My bank relationship manager.”

“Oh! so you bought it from the bank.”

He probably sensed the disappointment in my voice.

“It’s OK man. I had a few favours to return to them. Besides, I get to see all my investments in one place.” He said it as a matter-of-fact.

“OK. If you feel it is good for you, so be it.” I said with a feeling of resignation.

“Listen, I made one more investment. It is even better.”

“What’s this one?” I could not hold back my surprise.

“I invested in the Prudence fund. I invested Rs. 15 lakhs. After 1 year, I will get a dividend of Rs. 10,000 every month, that too tax-free via something called systematic withdrawal. After 10 years, the fund value will still be double my invested amount.”

“What makes you so sure about these outcomes?”

“What do you mean?”

“I mean what is the certainty that you will receive Rs. 10,000 a month for 10 years and yet you will have a balance of Rs. 30 lakhs odd in your investment.”

“Well, the relationship manager told me so.”

“Is that a mutual fund or a Fixed Deposit?” I took a pinch.

“A mutual fund, of course.”

“Then you should know there are no guarantees in a mutual fund. It may happen or may not happen. Have you considered the scenario that there may not be funds left to pay you your monthly dividend after a few years?”

“Oh, I didn’t think about that. Is that possible?”

“Given the fact that the Prudence fund invests in market-linked securities, such a possibility exists.”

“Goodness. I really fell for the dividend bit and double the value after 10 years.”

“Not just that, you also fell for the micro cap. It was a nice micro way to earn some commissions. By putting you in a closed ended fund, your bank guaranteed itself the commission flow for the next 5 years. By the way, no guarantees for you.”

“Ah man, I don’t listen to you and I mess up.”

“Well Nikhil, you like taking expensive lessons.” I winked at him.

—

What’s common between an NFO, Closed ended funds, Dividend and STP?

All these are used as tools of mutual fund mis-selling on unsuspecting customers.

Throw in a private bank and it becomes the biggest customer fleecing schema of all times. You see banks are living tales of what mis selling is all about. There are unscrupulous distributors too who take part in this fleecing.

What is mis-selling?

There is a definition by SEBI on what is mis-selling. To me mis-selling means doing any or all of the following.

• Misrepresentation of facts
• Overstate possible benefits or gains
• Understate possible losses
• No disclosure of all risks, costs or consequences
• Using language that plays on greed or fear

With that understanding, there is enough mis-selling happening around. While the top award goes to life insurance, mutual funds too are catching up.

Mutual Fund Mis-selling – The red flags

Like Nikhil, you too can be subject to mis-selling. Here are a few pointers which should raise a red flag for you.

#1 You are pitched a dividend option. Why ‘o’ Why? Dividend is just a way to get your attention for the sale. For some, it is just an indicator that the investment is active and rewarding. The gains become visible with dividends, else it is all on paper.

What to do – If you are planning to invest your money for long-term growth, a dividend option makes no sense, whatsoever. What will you do with the cash any way? Squander it!

#2 You are asked to do an STP or a Systematic Transfer Plan because markets are at a high. This is a call on your fear. Almost all investors at any point say that the markets are high. Fine! But the strange thing is that only the new investments subject to this logic. What about your existing investments that are already exposed to the market? Aren’t they also in the current “high & heated market”?

What to do – Focus on your asset allocation. If in a heated market, your equity allocation is overweight, redeem and invest in other non-equity assets, else go ahead and invest more money. Remember though, you have to choose the right funds.

#3 Every New Fund Offer is an appeal to your wish for novelty. Throw in the closed ended fact and it sounds like a special scheme launched just for you. Beware! It’s a trap.

What to do – Always look at comparable existing funds with a track record and give the money to them. A new fund that brings in something absolutely unique can be considered, else ignore. Closed ended funds can easily be said NO to.

#4 Then there is the lure of the monthly income and comes in a fund with the name embedded – Monthly Income Plan. It is a debt fund with some allocation to equities will contain risk and yet be able to give higher returns than a normal debt fund or FD. It is one of the biggest trick in town plus it is a highly tax inefficient method. Why would you take exposure to equities through a debt fund and pay tax? Also, there are NO guarantees that you will receive an assured monthly income.

What to do – As soon as you hear the words “monthly income plan” with a mutual fund, run with your money.

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You need to ask your questions based on the pointers above and any more that you feel should be asked. Don’t let your greed or fear rule you.

“Oh man! I definitely need to be more careful with my investments. Thank you for this.

“You are welcome, Nikhil.”

What else is a red flag for mis-selling? Tell me.