Build your mutual fund portfolio with care

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Once you begin investing in mutual funds, do not constantly monitor or fret about it. The concept of mutual fund investing is based on you being a passive investor. Some pointers on how to build your mutual fund portfolio.

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Shanthi Venkataraman

What’s up in the stock market? If you do not know and don’t have the time or the inclination to find out, then mutual funds may be the better option for you. But before you contact the distributor near you, be prepared to do some homework first. Though you may have someone else to manage your money for you, you still need to build your mutual fund portfolio with care. Here are some pointers to get started.

Determine investment amount: If you have just begun saving and do not have a significant surplus in your bank account, start small. Begin by investing a few thousand rupees every month. Systematic investment plan (SIP) is a good option for those who wish to build their fund portfolio gradually. As it works on auto-pilot, it prompts saving in a disciplined manner. It also minimises risks of bad timing of investments. Once you become a more seasoned investor, capable of timing your entry into the market, you may choose to invest a lumpsum amount. Remember to invest in equities only that sum of money that you will not require for at least three years.

Allocation pattern: Before you begin to short-list funds, sketch your basic allocation pattern. Your portfolio of funds must have an allocation pattern that meets your return objective and is in line with your risk profile. Young investors with a moderate-risk appetite, for instance, can have a 60 per cent allocation to large-cap oriented funds and a 40 per cent allocation to mid-cap funds.

You could create a core and satellite portfolio. Your core portfolio of funds should typically be plain vanilla diversified funds that have outpaced markets consistently over a three-five year period. Hold these funds for at least a three-five year period.

You can allocate a small portion of your portfolio, say 20 per cent, to funds you would like to experiment with. For instance, sector funds or international investing funds or value or contra funds. These funds can help enhance the overall returns. But such funds also carry a higher risk profile and may outperform in short bursts. As such, they may require more frequent monitoring and you will have to be more active in booking profits on these funds.

Short-listing funds: Once you have decided your allocation pattern, you can arrive at a short-list in each category — large-cap, mid-cap, blended cap funds. A fund’s performance track record is probably the most important criterion for selection. But do not let your investment choices be guided completely by recent fund performance. Instead, choose funds that have outperformed their benchmark and the markets on a consistent basis.

There are now several Web sites that provide you with mutual fund options. Identify funds that figure in the top 25 per cent of the fund rankings across time-frames in each category. Once you short-list the funds, you can zone in, depending on your return objectives and risk profile.

Qualitative factors: Besides performance, you need to consider qualitative factors as well. This requires some more effort, but is necessary for those who are serious about building wealth. Visit individual fund house Web sites and take a look at the fund’s objective or mandate as defined in its offer document. The fund house can, at times, define these objectives rather vaguely. Try and identify funds that have a well-articulated strategy and that tend to largely stick to their investment objective. Conviction in ideas is something to be valued. If a fund has a loosely defined investment objective, it might stray from its mandate, which will defeat the purpose of your investment.

Diversify your portfolio well. Do not choose too many funds from the same fund house. Choose funds with different styles of management. For instance, some funds may tend to diversify their portfolios substantially, limiting individual stock exposures to 5 per cent. Others may take concentrated sector exposures.

Some funds may aggressively churn their portfolio. Ultimately, the fund must be able to compensate you for the risk taken. Invest in a mix of management styles to maximise your returns for a given level of risk. Read interviews with fund managers. It might give you a better idea of their conviction/ capabilities. Track changes in fund management.

Number of funds: Once you have identified funds that match your criteria, how many funds should you invest in? There is no ideal number. If your objective is purely diversification, even five funds with different styles should suffice. More funds may lead to significant overlap of stocks and sectors.

Tracking the performance of a large number of funds also becomes cumbersome. If you are using the SIP route and investing small sums, limit the number of funds to three to five. As your investment surplus swells, you may invest in up to 8-10 funds. But beginners may limit their holdings to a handful of funds.

Tracking portfolio performance: Once you begin investing in funds, do not constantly monitor or fret about it. Remember, the entire concept of mutual fund investing is based on you being a passive investor. However, do review the performance of your funds once in six months. Compare funds to their benchmark and then to their peers. There could always be temporary blips in performance. But this is no reason to re-draw your portfolio.

A mutual fund needs to be treated as a long-term investment vehicle and should be held at least over a two-three year period. Fund managers take a long-term view of the markets. Therefore, you need to stay invested with the fund for a long period to realise the full benefits of its investment strategy.

The usual caveats: Avoid investing in new fund offers, unless the offering is unique. Do not be lured into investing in funds by dividend declarations. They make no difference to your wealth. Do not choose a fund based on its relatively lower net asset value.

NAV is nothing but the market value of securities held in a fund’s portfolio. A fund that has a higher NAV probably has a longer track record or has been a better performer.

 

 

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