Mutual funds for your child

Rarely have we seen a time when parents were overwhelmed with so many investment options to help them plan for their children's future. It is equally true that often parents find themselves so preoccupied that they can't seem to find time to manage their own commitments, let alone plan for their children's education and marriage among other events. That is why it is important that they get some professional help. This is where mutual funds come in.

Put simply, mutual funds hire the services of a professional money manager to invest on behalf of a group of individuals. The individuals pool in their savings and leave it to the fund manager to manage their money in an optimal manner. Individuals can go about their work as usual, content in the knowledge that there is professional help at hand.

Mutual funds have much to offer to parents. Consider this - you have office work to complete, household work to do, children's homework to help with and whole lot of other social and personal commitments to take care of. In the middle of all this, where is the time to invest for your child's education or marriage or business?

Say hello to child plans/funds. We mentioned that mutual funds invest on behalf of individuals to achieve a pre-determined objective. For many investors, this objective is planning for a house, retirement, an overseas trip, parking surplus money. For parents, this objective can be 'planning for child's education or marriage or seed capital for his/her business'.

Parents must note some peculiar feature of child funds. These features tell parents exactly what makes these funds tick. It gives them a reason to consider these plans for building a corpus for their children's future.

Investment objective
The good news for parents is that there is common ground between their objectives and the objectives of child funds. Child funds are launched with the explicit objective of helping parents build a corpus. Sample this - Principal Child Benefit's investment objective reads - 'To generate regular returns and/or capital appreciation/accretion with the aim of giving lumpsum capital growth at the end of the chosen target period or otherwise to the Beneficiary (child).'

Even more explicit is UTI Children Career Plan's investment objective - 'to provide children after they attain the age of 18 years a means to receive scholarship to meet the cost of higher education and/or to help them in setting up a profession, practice or business or enabling them to set up a home or finance the cost of other social obligation.'

Asset allocation
Although most child funds take on a degree of risk by investing in stock markets, they are relatively less risky compared to diversified equity funds that can invest upto 100% of their assets in equities. They are relatively less risky because fund houses have taken adequate measures to ensure that child funds are managed conservatively.

The most important measure adopted by fund houses is to cap the equity investments at a reasonable level. Most of them have capped the equity weightage of the portfolio at varying levels, usually not exceeding 70 per cent of the net assets.

These funds have the flexibility to invest in equity and debt markets depending on the fund manager's view on these markets. These funds work like asset allocation plans allowing the fund manager to shift across asset classes so as to maximise returns for the investor.

For instance, in an equity fund, the fund manager is usually compelled to remain completely invested in equities even when stock markets appear overvalued and therefore poised for a correction. But a child fund with a cap on the equity component can always shift a portion of its assets in debt when the going gets rough.

On the same lines when equity markets are overvalued, the fund manager can shift a portion of his assets to debt so as to capture gains. When equity markets decline, he can add to the equity component. By smartly allocating assets across debt and equities, he can ensure that he enters low and exits high, the cornerstone of a successful investment strategy

Lock-in
We mentioned that fund houses make provisions to ensure that the risk associated with child funds is controlled. One way to lower the risk of equities is to make long-term investments. Over the short-term equities are the riskiest assets; over the long-term, if you tread wisely, they can generate the best risk adjusted returns for you. That is just what fund houses do; they give the fund manager the time and flexibility to make really long-term investments in the child fund. For that, they have what is commonly referred to as a lock-in period.

If you are an investor in public provident fund and National Savings Certificate then you already know what a lock-in period means. In fact, fixed deposit investors are equally aware of this term. Only difference is that child funds have an equity flavour, while NSC, PPF and FDs are debt instruments.

Reason why it makes imminent sense for equities to have a lock-in is because they demonstrate their potential over the long-term (at least 3 years in our view). When the fund manager is certain that he can invest the money for a longer period of time without being concerned about the investor standing outside his office demanding his money, he can make more prudent investments that stand a good chance of making money over the long-term.

For parents, who want to build a corpus for their children over the long-term, a lock-in must be seen as an ally for two reasons. One, it enables the fund manager to make investments that are in the investor's long-term interests. Second, it acts as a deterrent for the parent from making premature withdrawals.

As parents will appreciate, child funds have a lot of features working for them. Even if some of these features appear restrictive in nature (cap on equity investments, lock-in period) remember over the long-term they work to the parent's benefit. They instill discipline and have the potential to generate a corpus for the child, and in the final analysis that is all that matters.