As a child I used to love fruit salad. The mix of fruits with custard and icecream used to enthrall me. I used to have it with a relish that bordered on a famished man seeing food! Would a fruit salad without all the fruits have been as good? I had never thought of it. But these days when people are calorie conscious and have advice from their doctor about which fruits to have and which ones to refrain having, I have started to look at the fruit salad in a new light.
I still have fruit salad… but now I’m more conscious about the various fruits that make up this heavenly concoction. Individually, they are nice. It’s when they are together, they taste sinfully delectable.
It is something like that when putting together an Equity MF portfolio. A portfolio which have only largecaps would be like having a salad made of just bananas – there would be no colour, variety or variation in taste. I don’t think it will be half as appealing.
A properly constructed portfolio needs to have exposure to varying extent to the different types of MF schemes. Just which type of schemes should be in the portfolio is something that can be decided based on individual requirements.
There are however broad pointers to constructing a portfolio. The first rule is to select the base or the bedrock schemes that will be building blocks of the portfolio. These will be the stabilisers of the portfolio. Large-cap, Index funds & Equity oriented balanced funds would come in as important components of the bedrock portfolio. Large cap funds by it’s very nature would have low beta and would represent the large, well-managed companies which are the market movers and mostly are also leaders in their category.
Index funds score as they represent the index – the fund mimics the correct proportion of the companies in the index. Index funds are hence passively managed funds. The only role a fund manager plays is to constantly ensure that the fund has the correct proportion of the underlying stocks of the index. Since the index itself is dynamically managed to represent those which have the largest market cap & are among the most liquid equities it is positive to have index funds in one’s portfolio. Also index funds have some very low expense ratios. Index ETFs are even better as their expenses are even lower.
Balanced funds ( equity oriented ) have atleast 65% in Equity schemes. The advantage in investing in these schemes is that since there is a certain equity debt allocation that a fund manager seeks to maintain, it can potentially take advantage of upsides and downsides. When the market is going up, the fund manager can move some portion of debt to equities and in the reverse swing, it could be exactly the opposite. This ensures that there is a bit of rebalancing which tends to happen in these kinds of funds.
The next level would comprise of aggressive / actively managed funds. Aggressive funds would choose from mid-cap & small cap space. These funds have the potential to deliver high returns though the risk inherent in such a fund is also higher. Their volatility tends to be higher as the underlying companies in which they invest in would be fast growing companies but they could also get affected to a greater extent due to any external impact like inflation, interest rates, commodity prices etc., more than a large cap company, which tends to be market leaders and have higher pricing power, may have better forward and backward integration leading to higher capacity to absorb external shocks. But in the longer term, they tend to perform well. Actively managed funds would be all-cap funds where the fund manager invests across market caps and themes and will take calls on which sectors to invest in, what kind of companies to invest in etc. This calls for a higher degree of skill on the part of the fund manager. Some of these funds have performed well and have managed to beat the index consistently over long periods.
For those who are bullish on specific sectors, sectoral funds are good options. For instance, investing in Pharma or FMCG would help in ensuring that there is stability in a volatile markets. Similarly, Media & entertainment & pharma are vast sectors, where one can get proper representation in these sectors only by investing in such sectoral funds. Thematic funds like Lifestyle & Infrastructure funds are tactical allocation calls, which depends on the portfolio one is trying to construct. Similarly, funds with exposure to equities abroad, commodity oriented, particular country theme etc. can have a place in one’s portfolio based on the diversification one is attempting to achieve in terms of geographies, underlying asset class, economy/ currency diversification.
MF schemes available now allow one to construct exactly the portfolio that is suitable to one’s situation. Like the fruit salad, it tastes good when they are put together in the right proportion.
Article by Suresh Sadagopan; Published in Moneycontrol.com on 17/6/2011
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