Smart investor: Choosing funds for SIPs

A decade ago, choosing an investment option for monthly savings was a lot easier. Most investors went with time tested products like recurring deposits, public provident fund. The interest rates were good enough at 9% and there was no need to look at other options. In the last decade, a lot has changed for the Indian investor.

The stock market is no more an unknown devil for many and in fact, even insurance is being linked with equity option. The focus on SIPs has been such that young professionals are looking at the concept to begin their investment journey. Now, the challenge for many is not the acceptance of the concept but the choice of right scheme. It is not an easy task as markets have turned highly volatile in the last couple of years and the prospects of sectors have been changing at a rapid pace. If infrastructure was the theme in 2007, it has proved to be a dud in the last couple of years. Similarly, mid and small cap funds which are generally tipped to be top performers in a booming market environment can make the investor sit on the wrong side during bearish phase.

So the question is: how does one choose funds for SIPs? In fact, a friend called up a couple of weeks ago as to whether he should go for five funds of Rs 20,000 each for a monthly SIP of Rs 1 lakh or stick to a single fund for easy management. His argument was when SIP in itself is a product which reduces risk, why bother about investing across too many funds?

While SIP no doubt provides better management of risk, the returns can vary depending on the market environment and the period of entry. For instance, if an investor had signed for an SIP in January 2009 for a period of one year, his returns were better than one-time investment because of market volatility. Can the same be expected over the coming years? The answer is no because the volatility within stock prices tends to settle down over a period of time and hence the returns too get evened out over long term. If you take a look at the performance of diversified funds over a period of five years, the annualised returns are in the range of 20% for most funds.

So for an SIP should an investor choose a volatile fund like sector funds which offer plenty of dips and highs or stick to diversified funds which are more stable in the long term? The answer is both but one needs better management of entry and exit points in the case of sector funds. As you can see in the table, sector funds have outperformed diversified funds during 2007-09 when markets were volatile.

One of the best options would be to opt for a combination of both. While sector funds can be passively managed and used for long term needs like retirement or child’s future, sectoral allocation can be for medium term with 3-5 year view. As pointed out earlier, one should get into the habit of booking profits from such allocation during market peaks and use debt products for parking profits. The same can be reinvested during steep correction. More importantly, keep an eye on the cyclical fortunes of sector funds. Even here, one need not churn aggressively, if the sector is like banking which is more aligned with the fortunes of the overall economy.

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Tags: Systematic Investment Plan

Category: Mutual Fund, Personal Finance