Investing in mutual funds – building a balanced portfolio

I have in the past blogged about going about investing here. I will jump a step and write about building a balanced mutual fund portfolio. I will address the debt side of mutual funds in a separate post on building your debt portfolio, so this post refers to only equity funds. Some steps I think are critical –

1. Get the funds right – Portfolio theory and investment theory says, diversification helps – the same applies for a mutual fund portfolio too. So you should plan to build one. And Remember this is going to be long time bound, non exciting, non sexy action which will make you cringe when the guy in the next cubicle is boasting of his 70% profit. But trust me, if you are not a gun in stock picking and don’t have time, go for mutual funds. A well balanced portfolio needs to have these funds I think

a. Core equity funds – Here you should have two sets of funds : one a bottoms up stock picking type with a large cap bias and will usually be stable in their returns and move with the Sensex or Nifty. The second should be a good growth fund that bets on the growth stocks. Remember although growth stocks tend to be the mid cap/ small cap stories, a growth fund targets returns and not capitalization. This should be a large chunk of your portfolio maybe ~40%. In case you are investing for the sake of tax saving in ELSS funds, then add them here.

b. Index funds / Exchange traded funds based on the index – This will allow you to ride the market direction with a lower expense load. Choose from a wide range of index funds or ETFs available. Keep in mind that if the core equity fund you chose has a largely the same companies as the index fund then you are losing the benefit of an exchange fund and losing on the expense. This should be ~20%-25% of your portfolio

c. Contra fund – This takes bets on stocks which are currently out of favour with the market. Use these funds to give that occasional punch to the portfolio and this should be about 15% of the portfolio.

d. Thematic / Go anywhere funds – These are funds with a mandate to go anywhere, invest in any story and take concentrated bets or diversify. In a volatile market like India these are funds which, if nimble, will make money due to emerging themes. This should be about 15%of the portfolio

e. Sector funds – These take concentrated bets on a particular sector. Ride the momentum and languish when the sector goes out of flavor. Send in 10% of the portfolio here.

2. Getting the mode of entry right: I would suggest you setting up a SIP on the core equity funds and the thematic funds, while sending those sudden bonuses and one time investments into the contra and sector funds. Remember the latter will increase the risk of market timing.

3. Watch the loads: some funds levy a higher entry load while others link it to an exit load with period of investment. ETFs and index funds have a lower load structure. Remember, loads eat into your returns.

4. Monitor your portfolio regularly: I would suggest a quarterly review, with a rejig once/ twice a year. Don’t touch your MF investments for 3-5 years atleast, see them grow. Use a good portfolio tracker like the one you find on sites like www.Valueresearchonline.com

5. Options – You will find Growth, bonus and dividend options. Dividend will have reinvestment and pay out options. Forget all these, remember, if u don’t need the money, choose growth and if u need the money choose dividend payout. The others don’t matter; they are a vestige of a period long bygone where taxation was an issue. But remember, if you investing in a ELSS fund to save tax, it makes sense to always choose the dividend option, since every investment is necessarily locked out for 3 years. You don’t have an exit option.

6. Forget the NFO’s go for good old tried and tested funds – very rarely do new ideas come to the market, when they do go for new fund offerings, else just invest in funds which have a track record. Although past performance in no guarantee of future, atleast it’s a better option than the new unknown

7. Close ended fund or open ended – the spate of NFO which claim to be better because they are close ended and hence give the fund manager a better control on investments , although true a little bit, is driven by the change in rules for amortizing the expenses. So cut through the crap, go for old funds, open ended and with a track record.

8. Throw your advisor out of the window if the first recommendation he makes is to invest in an NFO, unless he has very strong reasons about what is new about the fund and how there are no such funds available already.

9. Remember the difference between absolute performance and relative performance – All Mutual funds will boast of how they outperformed the market, but they are referring to relative performance to the index they chose to be benchmarked against. So if the index fell by 150% and they fell 149% they will still claim to have done better. And remember to include that load when you are calculating the returns. Me and you are bothered about what is the absolute performance… go back open the 7^th standard mathematics text book and learn how to calculate simple returns if you are not sure..

Happy investing , in a country where financial assets are a piddle , use this mode till you feel comfortable to venture alone in the jungles of the Indian equity market