How to build a Mutual Fund Portfolio
It’s rare to find a 20-something into his first job considering long-term investment. For many, the Employees’ Provident Fund (EPF), which earns 8.5%, is the only investment running. While conventional wisdom says that the younger you are, the more you should invest in equities, few are able to follow it—either due to lack of enough disposable income at that stage or lack of initiative or awareness.
Investing in the stock market directly may be daunting, an option is going through the mutual fund (MF) route.
The debt-equity ratio
Some fund managers claim that 100 less your age is how much you should have in equities. So, if you are 30, your equity allocation should be 70%.
While that may be true in some cases, it doesn’t always make sense. “I may be a 60-year-old retired person with good savings and means to fall back. I may also have no dependants, just me and, say, my wife. I should invest in equities,” says
Jimmy Patel, chief executive officer, Quantum Asset Management Co. Ltd. Patel advises investors to ascertain their risk appetite before following the age-equity rule.
However, Fortis Asset Management Ltd’s chief executive officer Nikhil Johri feels that age is important. He says: “Once you cross, say, 60, your ability to earn returns and withstand shocks goes down, compared with when you are young.” What Johri means is that had you invested a large chunk towards the end of 2007 when equity markets peaked, you would still not have recovered all your money and made a sound profit owing to the downturn.
Being equity-heavy doesn’t make sense for people, who don’t have time on their side.
Equity investment
Core and satellite: Ideally, you should adopt a “core” and “satellite” approach. While core schemes are those in which you would stay for the long term, satellite schemes are seasonal funds, such as sectoral or thematic that add a flavour to your portfolio.
Even plain-vanilla funds that are promising but do not have a long track record can be part of your “satellite” portfolio. For instance, Mint50, Mint’s chosen set of 50 schemes across categories, lists Religare Tax Plan as a “satellite” tax-saving equity fund. Though the fund has a good track record, it has completed just three years against well established peers such as HDFC TaxSaver and Sundaram BNP Paribas Taxsaver.
Large- or mid-cap: Start with putting money in large-cap funds. Since these funds invest in large and well established companies that come with a track record, they are less volatile than mid-cap funds.
For instance, in the 2008 market crash, mid-cap funds lost 60% on average against a loss of 53% by large-caps. But mid-caps can outperform large-caps in rising markets. Between April and December 2009 when equity markets bounced back, on an average, large-caps returned 108% against 123% from mid-caps over the same period.
Satish Ramanathan, head (equity), Sundaram BNP Paribas Asset Management Co. Ltd says it makes sense to have a comfortable exposure to large-cap funds. “Once the foundation is built, you can start investing in mid-cap funds,” he adds. This way, says Ramanathan, even if markets correct by, say, 5-10%, you won’t “burn a big hole in (y)our pockets”.
Active or passive: Against active funds where the fund manager decides which scrips to buy or sell and when, passive funds invest their corpus in all the scrips, in exactly the same proportion as they lie, in their benchmark indices.
Abroad, exchange-trade funds (ETFs) are very popular as most active funds have failed to consistently beat the markets. In India, index funds and ETFs haven’t really taken off in a big way yet, but are gaining popularity. For instance, on 5 February, Nifty BeES, India’s first ETF, was the 69th most liquid scrip on the National Stock Exchange. On a few other days, too, in the recent past, Nifty BeES has been one of the most liquid scrips in the market.
However, unlike the US markets, the Indian markets have seen a fair number of actively-managed funds outperform passive funds. For instance, in the past year, active large-cap funds returned 95% against 89% by Benchmark Nifty BeES, a large-cap ETF. But ETFs, too, have given superior returns. Against 123% returned by active mid- and small-cap funds, Benchmark Junior Nifty BeES, India’s only mid-cap oriented ETF, benchmarked against Nifty Junior index, returned 196% in the past year. This was the highest among all active and passive mid-cap-oriented funds.
Debt investment
While equity funds help create wealth over the long term, most debt funds are either seasonal in nature or offer temporary help. Your EPF and Public Provident Fund should ideally take care of your long-term debt needs, thanks to the high and guaranteed income from these.
However, you can use debt funds to your advantage depending on what your needs are. For instance, if you wish to park your cash for around three-six months, look at ultra short-term debt funds and for up to one year, look at short-term debt funds. For retired senior citizens looking fore regular dividends, monthly income plans (MIP) are an option. But since dividends are not assured, the first preference should be 9% Senior Citizens’ Savings Scheme and 8% Post Office Monthly Income Scheme. Alternatively, if you wish to earn a cumulative income (no dividends, but principal and gains at the end of the term), go for the growth option of MIPs.
How many schemes?
There isn’t a fixed number as such. Experts suggest that you must invest in not more than ten schemes. Hiren Dhakan, associate fund manager (fund-of-funds), Bonanza Portfolio Ltd, a Mumbai-based financial services firm, says: “Your portfolio can be well diversified between six to eight MF schemes as you can easily get an exposure to around 200 to 300 unique stocks and different management styles.”
Too many funds also make it difficult to track the portfolio and a rise in any of them may not have much of an effect on your overall portfolio.
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