Aruna has identified a few financial goals and her adviser has told her how much she should save regularly in the equity markets. It is fashionable to assume that one can pick a few winning stocks and do better than a fund manager. However, Aruna’s adviser asked her to consider the time, effort, cost and, most importantly, portfolio’s performance track record before using the DIY approach. Aruna is now convinced that she wants to invest in equity mutual funds in a systematic manner. However, she does not know how to select funds to create her investment portfolio. Should she trust the list given to her by the adviser? What parameters should she look for while selecting mutual funds?
The simplest and least expensive mutual fund product is an index fund or an ETF. It will give Aruna exposure to equity without the risk of selection. Funds routinely publish performance data stating that they have beaten the benchmark by a good margin. What the data essentially means is that Aruna will earn this return only if she invests in the winning fund at the right time as these are point-to-point returns. If Aruna’s fear is that she may not always select well, an index fund is a good choice to begin with, till she has learnt the ropes.
It is important to realise that a new fund offer at `10 is not cheaper than an existing fund at, say, Rs.100. It is like considering the Nifty to be cheaper at 20,000 and the Sensex to be expensive at 80,000. Would you consider the Nifty return to be higher because it is cheaper? An NFO simply has a lower nominal value and cannot generate a higher return than an existing fund just because it is priced at `10. An existing fund, on the other hand, has a track record.
Instead, Aruna should make an effort to know what a fund does, and how. She should not make a choice without clarity on how a fund delivers returns. She must focus on understanding its portfolio strategy and how true the fund is to its stated strategy. For example, if the fund states it will hold large-cap stocks, then 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 is dishonest. In other words, if Aruna would like to have a set of index, large-cap, mid-cap and sector funds, she should choose the funds that stick to this definition. She could explore the portfolio and performance on the fund’s website or research rating agencies, such as Value Research or Morningstar, over the last 6-12 months. Strict Sebi guidelines with respect to fund nomenclature and categorisation linked to fund strategy are now in place. Aruna must also remember not to rely on past winners as they seldom repeat themselves. Different funds do well at different points in time.
What might work for Aruna would be building her portfolio using the core and satellite approach. At the core of her equity portfolio should be index funds and largecap funds. The next layer should have mid- and small-cap funds. The next layer should have funds that need a review more aggressively and should not comprise over 15% of her portfolio. Sector funds, focused funds and thematic funds fit in here. These will only do well seasonally and need close monitoring.
Content courtesy Centre for Investment Education and Learning (CIEL).
Contributions by Girija Gadre, Arti Bhargava and Labdhi Mehta.