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The Mutual Perils of Pricing

In following historic pricing but offering exit at NAV, a fund cannot be fair to its investors.

By Dhirendra Kumar

Any definition of the mutual fund is as simple as the term itself: it is a professionally-managed pool of funds raised from individual investors to achieve the twin objectives of portfolio diversification and investment ease. However, this is marred by the complicated pricing policy followed by some mutual fund managers, which adds a needless element of risk to such investments.

The flaw is simple. Typically, the units of many a public sector fund are bought and sold at their historic prices--which could be either a month old or a few days old--while the value of the underlying assets changes every day. Take, for instance, the UTI's largest open-ended equity fund, Mastergain 92, which is sold at its latest Net Asset Value (NAV) while it is purchased at less than its previous week's NAV. In other words, on February 8, 1999, Mastergain 92 could be bought at its NAV of February 3, 1999.

However, the volatile stockmarkets can boom up or bust down by even 100 points in a 5-day period. This means that a smart investor has the opportunity to buy Mastergain 92 at a lower price if the stockmarket goes up subsequently, or to sell at a higher price if the stockmarket is falling. This can be done virtually without any risk since the transactions affecting the next week's trading would have already taken place. Unfortunately, the real loser is then not the UTI, but the other unit-holders in the scheme.

This so-called historic pricing helps the short-term investor more than the long-term investor. Such a bizarre pricing policy is followed by all the UTI's open-ended equity funds--Mastergain 92, Masterplus 91, Grandmaster 93, and Primary Equity--besides Canbank Mutual's Canganga, and the GIC Mutual Fund's Growth Plus II and Fortune 94. At the same time, there are funds--like Alliance, Birla, ITC Threadneedle, JM, Kothari-Pioneer, and Templeton Mutual Fund--which follow the more equitable forward pricing model based on daily NAVs, which allows every investor to purchase and sell at the fund's exact value.

By following the historic pricing route, but offering exit only at the current NAV, a fund manager cannot be fair to the investor. It will always be the active investor who buys and sells frequently who will grab the best from the fund at the cost of its long-term investors. Since this is a faulty mechanism, all the mutual funds must move to the forward-pricing mode. If it is still being followed, it is only because of habit and convenience.

If you ask me, historic pricing should be abolished by the Securities & Exchange Board of India, and forward pricing should be made mandatory. Until then, long-term investors in open-ended equity funds like those of the UTI, should exit from them as early as possible, and short-term investors seeking risk-free returns should use their circulating capital to make some quick money from these funds. .


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