How to build a Mutual Fund Portfolio

June 17, 2010

in Stock-News

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.

How to build your Mutual Fund portfolio?

Published on Tue, Apr 03, 2007 at 17:54 | Updated at Mon, Apr 23, 2007 at 11:53 |
Source : Moneycontrol.com
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Great salaries, excellent bonuses, fairly valued markets, high interest rates – the time looks
just perfect to design and put together your mutual fund portfolio.
Building a MF portfolio is akin to building and furnishing your own home:

RELATED NEWS

 Growth or Dividend – Frankly speaking it’s irrelevant

 The ABC of Exchange Traded Funds
 Should I put my money in Capital Protection Funds?
 Mutual Fund resolutions one must follow in 2007

 Will Bond regain its old glory?

a) It depends on your financial capacity

b) Your personal tastes and preferences
c) Requires a lot of patience and care

Therefore, while there cannot be a model portfolio suiting everyone’s needs and objectives, you
can follow a few general rules to build yourself one.

Be clear of what you want

To begin with, you must decide what your financial objectives are; and how much risk you are
willing to take to achieve those objectives.

The goals should be as precise as possible. For example you goals could be

• Rs 50,000 to pay-off the personal loan in 2007

• Rs 2 lakhs for children’s higher education in 2012
• Rs 1 lakh for foreign trip in 2010
• Rs 7.5 lakhs for daughter’s marriage in 2015
• Rs 1 crore retirement corpus in 2020

Second, your goals must be realistic. They must be in line with your financial position and risk
appetite. No point in having too ambitious or too pessimistic goals; or having goals, which require
you to take undue risks. (Also read - How to profit from Mutual Funds?)

Devote proper time and thought to planning your goals.

Done? Good, that’s a major part of your job over. Once you know where you stand and where
you want to go, the rest is just a matter of details.

Match each goal with the appropriate MF category

Equity markets are too volatile in the short-term, but can give good returns in the long run. Debt
funds, on the other hand, give steady but low returns. Therefore, select the goals, which you will
finance through equity funds and through debt funds.
Assuming your retirement is still 15 years away, a predominantly equity portfolio may be a better
option.

But for your personal loan, which is payable just one year hence, debt funds will be more suitable.

And for the medium term, like your foreign trip, balanced funds may be the right answer.

Liquid funds are a nice way to park your very short-term funds.

Don’t be too concentrated or over-diversify..

contd on Page 2...

How to build your Mutual Fund portfolio?

Published on Tue, Apr 03, 2007 at 17:54 | Updated at Mon, Apr 23, 2007 at 11:53 |
Source : Moneycontrol.com
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Don’t be too concentrated or over-diversify

Depending on the corpus, one could invest in an average of 4-7 funds for an equity
portfolio and maybe 3-4 funds for the debt and balanced category. Too less a number of
funds make your portfolio concentrated and risky. Too many, makes it unmanageable and doesn’t
really serve the purpose. You need to strike the right balance. (Also read - Low on risk? Here's
how to earn better returns)

RELATED NEWS

 Growth or Dividend – Frankly speaking it’s irrelevant

 The ABC of Exchange Traded Funds
 Should I put my money in Capital Protection Funds?
 Mutual Fund resolutions one must follow in 2007

 Will Bond regain its old glory?

Also, while selecting the fund, study their portfolio mix and ensure that they are different.
If most of them are same, then even with 6-7 funds you won’t get the desired diversification.

In order to achieve diversification across asset classes, one could now look at some of the
forthcoming options such as real estate fund, gold fund, international fund etc.

Build a suitable mix of equity funds

Apart from allocating your corpus in different asset classes, you need to do some allocation
within the equity class. Index/Large Cap funds, Mid-cap/Small cap funds and Sector
Funds are the 3 broad sub-categories in which you have to divide your corpus.

Index and Large Cap funds will deliver steady returns, which will be in line with the market
performance. In the equity space, they carry lesser risk as compared to mid caps, small caps etc.
About 70-80% of your corpus could be allocated to this category. They provide stability to
your portfolio. Go for funds with moderate risk and consistent performance.

Your portfolio may need some kicker too. Mid-cap/Small cap funds and Sectors Funds have the
potential to provide higher growth (of course with a higher risk). Be prepared for a bumpy ride;
and sometimes crash landing too. A 10-20% allocation to this category may be okay. In case of a
bad performance, major portion of your corpus is still relatively safe. Large caps will minimise
your losses and will also bounce back quickly.

Don’t forget the tax aspect

Neglecting to pay tax is bad, but tax planning is not. It can help you to minimize your tax outgo,
legally.

Therefore, take care to choose the right option – dividend payout, dividend reinvestment or
growth. They may help you to save unnecessary taxes. (Also read - Dividend Reinvestment v/s
Growth – Let your taxes decide )

Make sure that you use the post-tax returns in your calculations. Else you may miss your target.

Having built a suitable portfolio, you need to nurture it. You have to regularly feed it with
additional investments. You will have to remove the weeds (poor performing funds) periodically.
And be patient. It takes time for the tree to grow. But once is has grown, it becomes strong – so
you don’t have to take too much care; and fruitful – it will give you returns year after year.

- Sanjay Matai

A word about returns

There is something called market returns which are best generated by index funds or
index ETF’s. We have various indices from the bell weather sensex[30 scrips] to
CNX500 which covers the entire market cap to a large extent. This is all about passive
investment style.

Having said this, when we are looking to beat the market returns, we are looking at active
investment style. Here we are looking for an alpha return from the portfolio. In simple
words, we are looking to beat the indices, be it the sensex or nifty or bse 100 or bse 200,
nifty junior, cnx 500, etc. Let us see where does this alpha come from.

• From individual stocks in case of stock investors

• From stock / sector picking skills of the fund manager in case of mutual funds.

As we are now talking about mutual funds, let us talk about the later case.

Core and Satellite Approach

It would be helpful to have a core and satellite portfolio. The core one to get market
returns and the satellite one to beat the market. The core objective is best met by
index funds / ETF / large cap diversified equity funds. The satellite one aiming for
alpha is serviced by midcap funds, value style, sectoral funds, etc. Depending upon
the risk apettite of the investor, the allocation to core and satellite portfolios could be
made.

Alpha Generators

So, when a portfolio is constructed, we need to be clear about where are we aiming for
this alpha. An experienced fund manager with strong track record would help in this.
More duplication of investment styles would not serve this alpha chasing purpose in the
long run. We need to identiy good alpha fund manager and combine it with investment
styles that suit our risk and return apettite and stay invested. It is important that these
funds are monitored to ensure that this alpha is generated. In the caes of large caps,
normally alpha comes from identifying promiing sectors early by the fund manager. In
case of mid caps, the alpha comes from identifying multi baggers in their initial stages. In
case of value style, the style of investing itself being bargain hunting, alpha comes from
investment style rather than stock picking. So, let us try to recap the alpha sources:

Large Caps – Sector Allocation Skills

Mid Caps – Stock Picking Skills

[Multibagger identification at early stage of the stock growth path]

Value Style – Style itself is the alpha source[looking for cheap valuations]

Common MF Investors Mistakes

1. Too much exposure to a few fund houses

2. Duplication in funds/ fund style / market cap. For instance having multiple small cap
value funds or multiple midcap funds, etc.

3. Heavy exposure to sectoral funds and mostly overlapping with other funds in the
portfolio. The purpose of sectoral funds is partly to get exposure to themes not covered
by other funds.

4. Over / Under exposure to market cap / fund types and / active – passive investment
styles

Suggested portfolio

[Aggressive]

1. Core : Large Cap – 30%

[Best served by an index fund. Suggest to look at CNX 500 /sensex/nifty funds or
diversified large cap equity funds]

2. Value-30%

3. Midcap-30%

4. Sectoral – 10%

[Moderate]

1. Core : Large Cap – 50%

[Best served by an index fund. Suggest to look at CNX 500 /sensex/nifty funds or
diversified large cap equity funds]

2. Value-20%

3. Midcap-20%

4. Sectoral – 10%

[Conservative]

1. Core : Large Cap – 70%

[Best served by an index fund. Suggest to look at CNX 500 /sensex/nifty funds or
diversified large cap equity funds]
2. Value-20%

3. Midcap-10%

Suggested VSFA PICKS

[It would be enough to choose one fund from each category keep in mind the above
portfolio related tips, lest the investor would be left with multitude of funds with
overlapping styles, themes,etc]

Index Funds

Benchmark S&P CNX 500

UTI Master Index

LargeCap Diversified Equity Funds

UTI Opportunities

Franklin India Bluechip

HDFC Top 200

Midcap Funds

UTI Mid Cap

IDFC Premier Equity Plan A

DSPBR Small and Mid Cap Reg

ICICI Prudential Nifty Junior Index

Value Funds

UTI Master Value

Tata Equity PE

UTI Dividend Yield

DSPBR Equity

ICICI Prudential Discovery

Sector Funds

Fidelity Global Real Assets Fund

Reliance Pharma

UTI Pharma & Healthcare

Reliance Diversified Power Sector Retail

Franklin Infotech

UTI Transportation and Logistics