Monday, March 12, 2012

6 tips for building a good mutual fund portfolio :

So you have a financial goal and your adviser has told you how much you should save regularly. You have also agreed that you will invest in mutual funds in a systematic manner. Now comes the tough decision of selecting the funds. Should you trust the list given by the adviser? What should you look for? Let me provide six pointers. I will restrict myself to equity funds here and deal with debt funds at a later date.

First, your requirement is to invest in the equity market. The mutual fund is only a tool to get there. Instead of choosing a set of shares yourself, you can ask a fund manager to pick them for you and pay an annual fee for a managed portfolio of shares. You are free to make the choice between doing it yourself and buying a mutual fund. It is fashionable to assume that you can pick a few winning stocks and do better than a fund manager.

However, consider the time, effort, cost and, most importantly, your portfolio's performance record before you do it. If you are honest with your analysis, you are likely to find the mutual fund choice compelling.

Second, the simplest and cheapest mutual fund product is an index fund or an ETF. It gives you the exposure to equity without any risk of selection. In practise, this risk is wished away by most investors and advisers. Funds routinely publish performance data, stating that they have beaten the benchmark by a good margin.

This may be factually correct, but you will get returns only if you select the winning fund at the right time. If you think you may not always select well, an index fund is a good choice. Even if you select good funds most times, the index funds in your portfolio will buffer your goals from the selection of wrong funds. Advisers earn the least commission on index funds, so don't wait for them to propose this product to you.

Third, a new fund offer at Rs 10 is not cheaper than an existing fund at, say, Rs 100. If someone told you that the Nifty is cheaper at 5,600 and the Sensex expensive at 18,000, would you buy the argument? An NFO is not cheaper than an existing fund; it just has a lower nominal value.

It cannot generate a higher return than an existing fund just because it is priced at Rs 10. An existing fund, on the other hand, has performance history, a track record. Unless it is an absolutely new idea, a new fund is an inferior choice to an existing fund.

Fourth, you should know what a fund does and how. You should refuse to make a choice without any clarity on how a fund will deliver returns. You have to do this amidst the marketing din of the fund house and the push of the adviser.

If a fund manager tells you that the fund 'uses a process-driven, bottom-up approach to select stocks across sectors, with a disciplined selling plan' he is describing his job. 

There is no special selling proposition here. If the fund says it will hold large-cap stocks, you know it will modify sector weightage and stock weightage compared to the Nifty index, to deliver a better return. If this fund delivers better returns by picking up a few mid-cap stocks, it will amount to dishonesty.

Fifth, be clear about what you expect the fund to do and what you will do yourself. If you like to assemble your set of index, large-cap, mid-cap and sectoral funds, choose those that stick to such a definition. If you see the portfolio and performance at the fund website over 3-6 months, you will know.

If you like the fund manager to do the juggling and like a loosely defined product, go for it, fully aware that you will not know what to expect. Investors like to give fund managers a long rope to do what they like as long as they deliver a return. This preference leads to more poorly defined products with fancy names. As a rule, the funds with vague names and promises are riskier than the well-defined ones.

Sixth, do not rely on past winners. In the mutual fund business, nothing sells like performance. Investors rush to winning funds, but seldom do winners repeat themselves. A large-cap fund will do well when the chips are down; in a bull market, a mid-cap fund will be the rage.

What is important is to hold a well-diversified portfolio and throw out what is not working. A portfolio suffers damage when you persistently hold laggards; it is all right to miss buying a few winners at the right time as long as you throw out the rotten apples.

So, what works? Build a portfolio using a core and satellite approach. At the core of your equity portfolio should be index and large-cap funds, comprising at least 50% of your portfolio. Pick three to four funds and invest in them regularly through SIPs. The next layer should have funds whose specific focus can be rewarding-mid-cap funds, infra funds, small-cap funds, value funds, contra funds.

These are diversified portfolios, but look at a specific segment or strategy. Pick three to four funds here. About 35% of your portfolio could be invested here. Review these at least once a year. Modify and throw out what is not working, and ensure you hold only the best.

The next layer should have funds that need an aggressive review. Sectoral funds, concentrated portfolios, specific strategies figure here. These will do well seasonally and need a close monitoring. This should comprise 15% of your portfolio and not over three to four funds.

If your portfolio holds too many names, acquired at different times for different reasons, you are doing yourself more harm than good. 

Source : ET

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