Can i Buy Mutual Funds Through Margin Trading?

The big question that mutual fund traders have on their minds is can I buy mutual funds on margin? That is an interesting question and we will come back to why it is practically tough in the Indian context. Here we try to answer the question; can you buy mutual funds on margins and also understand the key difference between mutual funds and equities.

Buy Mutual Funds Through Margin Trading

Let us first understand what margin trading entails? It entails buying security using a margin account, which is tantamount to borrowing money so you can buy more shares than you have the funds readily available for. You would agree that this is a slightly risky business as the leverage can work both ways. Just as leverage can magnify your profits, leverage can also magnify your losses. The problem arises because if your investment value goes down, you have lost not only your money but the money you borrowed. Remember, money borrowed on margin is a debt and has to be serviced. On the other hand, equity is not an assured source of return in the short term. Now we shall look at why this idea will not work in the case of mutual funds.

Three basic reasons are buying mutual funds on margin is not permitted at this point. A typical margin funding requires you to pay annualized interest of around 16-18%. Now that is not the kind of returns you can sustainably earn even on equity funds or sector funds. Hence you will end up with negative equity wherein your cost of funds is more than the yield you are invested. Secondly, the concept of a margin fund is a credit risk to the lender. Hence they need the daily value of collaterals on a listed platform that is transparent. Most open-ended funds are not listed and the prices are not real-time but they are based on the end-of-day NAVs declared by the fund. Lastly, margin funding works best when the churn is rapid and the yield can substantially better the proportionate cost of margin funding. That cannot happen in mutual funds, which is why margin funding is not available for the purchase of mutual funds.

The Difference Between Stock and Mutual Funds

Let us look at some key points of difference between Stocks and Mutual Funds. Equity stocks are a direct investment in the share market and are relatively riskier than going through a mutual fund. The other difference is that the pricing mechanism of equity stocks and mutual funds is different so these mutual funds cannot be bought and sold like stocks. When trading stocks, an investor can place limited orders, engage in short selling, buy on margin, and make trades in the secondary market throughout the day. Such things are not possible in mutual funds as you can just purchase or redeem at NAV linked price.

Mutual fund units are issued to buyers and redeemed from sellers directly by the asset management company or AMC or mutual fund as you prefer to call it. The fund announces the NAV or net asset value of all its schemes daily evening on all trading days and that is the applicable NAV for purchase and sale on the next day. Fund share buy-and-sell prices are not posted until the day after the transactions occur. This makes it difficult to get out of a mutual fund quickly when it is losing money. Since the exit is difficult, it is a reason most margin financers are not willing to fund mutual funds.

Equities, on the other hand, are traded based on real-time prices and reflect real-time news flows in the market. That is what makes equity trading a lot more dynamic, liquid and transparent, which is also what makes it much more amenable to margin funding.

Securities you Can Buy on Margin

Most of the listed securities and contracts can be bought on margins. You can trade intraday on margin, you can buy delivery equity on margin, you can even buy futures on margin and you can also sell options on margin. In addition, listed equity equivalents like exchange-traded funds or ETFs can also be bought on margin. That is a tad ironic, you cannot buy mutual funds on margin but it is possible to buy ETFs on margin.

Frequently Asked Questions Expand All

Most brokers allow pledge of most assets like mutual funds, ETFs and even gold bonds as collateral to take margin funding position. In all the cases, these securities have to be marked as pledge in favour of the margin financer before you can get the margin funding. Normally, equity funds will have a haircut of 40-50% just like equities, although some financiers may offer you a better deal. Then there are debt funds, where the haircut is much lower and the margin financer is willing to pay you up to 70-75% of the value of the debt funds as margin. Finally, in case you have gold bonds, it is possible to get margin on the gold bonds to the tune of 80-85% for margin funding. You can choose the asset accordingly.

You cannot buy mutual funds on margin. You have to buy it in cash account only. Margin financers are not willing to fund for mutual for practical reasons already enunciated. One way to leverage your mutual fund purchase is to select funds that are leveraged, but these are not too common in the Indian context.