Well-Rounded Portfolio

Dipak Mondal/Money Today        Print Edition: March 2013

Investing requires discipline, even if you regularly put money in mutual funds. Since mutual funds are run by professionals, these are considered good for those who do not have the time and knowledge to invest in shares and bonds. However, building a good mutual fund portfolio requires planning.

Though the ideal portfolio depends upon the person's risk-taking ability and age, investors must keep some broad points in mind while deciding which funds they should invest in.

A mutual fund portfolio should ideally be divided into two parts - core, for stability and predictability; and satellite, for investments that have a lot of potential but are risky.

This not only reduces volatility but also lowers the tax burden. "The premise of the core and satellite portfolio strategy is to minimise transaction costs and tax liability (short- and long-term capital gains) and manage volatility while looking for opportunities to outperform the market," says Shilpi Johri, Certified Financial Planner, and Head, Arthashastra Consulting.

IN THE CORE

The core, as the name suggests, is at the backbone and must comprise 70-90 per cent of the portfolio. Its aim is giving stability and decent returns.

Globally, index funds or passively-managed funds are the first choice for the core. An index fund replicates a benchmark index both in portfolio composition and returns. The fund manager does not have any say in stock selection, which eliminates the risk of wrong judgement. The fund management costs, too, are low. Because they invest in multiple stocks, index funds are well-diversified.

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Considering that in India actively managed funds have outperformed passive funds, the core portfolio should be a mix of index and large-cap funds.

Vishal Dhawan

Founder, Plan Ahead Wealth

In India, actively-managed funds have consistently beaten benchmarks over the years and are likely to continue to do so in the coming years. Therefore, activelymanaged large-cap funds can be a part of the core. These funds invest in large companies and are usually less volatile than mid- and smallcap funds. The portfolio core, if it comprises such funds, will not show any sharp drop or jump in value.

"Considering that in India actively-managed funds have outperformed passive funds, which is contrary to global trends, the core should ideally be built around a combination of index and large-cap funds that have a good track record and stable fund management teams," says Vishal Dhawan, founder and chief financial planner, Plan Ahead Wealth Advisors.

Equity-oriented hybrid funds can also be a part of the core. These funds have over 65 per cent exposure to equities and 15-35 per cent to bonds. Since the allocation to equities is higher, the returns are in line with those from equity funds. Plus, exposure to debt gives downside protection.

Gold ETFs and gold fund-offunds can also be a part of the core. But they should be limited to 5-10 per cent of the overall portfolio.

A part of the core portfolio can be used to meet short-term goals if you add debt funds, which offer downside protection.

"Ideally, the core portfolio should have a combination of accrual-based funds which follow the hold-to-maturity strategy. These could range from FMPs (fixed maturity plans) of different maturities to short- and medium-term funds with hold-to-maturity strategy," says Vishal Dhawan.



SATELLITE PORTFOLIO

The core gives stability while the satellite part of the portfolio is for earning above-market returns. The latter's objective is to generate high returns through aggressive products such as mid- and small-cap funds, sector funds, thematic funds and international funds.

Duration-based debt funds, which take active interest-rate bets, can also be a part of the satellite portfolio. These do not follow the hold-to-maturity strategy and instead try to profit from capital appreciation. Such funds invest in gilt funds, income funds and floating rate funds.

"Never use money from the core part to rebalance the satellite part. If the satellite part is not doing well, play to your strengths and stick to the core portfolio," says Shilpi Johri of Arthashastra Consulting.



REBALANCING PORTFOLIO

Periodic rebalancing (between equity and debt) of the portfolio is as important as creating a good portfolio. This helps investors keep up with the changing market conditions. We discuss different approaches for doing so.

Fixed ratio approach:
In this, you keep exposure to equity and debt at a certain ratio based on your age and risk-taking ability. If this changes significantly due to conditions in equity and debt markets, you shuffle the investments to the pre-determined ratio.

As an example, imagine a portfolio of Rs 10 lakh with 70:30 equitydebt ratio, that is, the equity portfolio is valued at Rs 7 lakh and the debt at Rs 3 lakh. After a year, suppose the equity portfolio rises by 12 per cent to Rs 7.84 lakh while the value of debt goes up by 7 per cent to Rs 3.21 lakh. Clearly, the ideal ratio (70:30) has been altered. It can be balanced by selling stocks worth Rs 10,500 and investing the money in debt.

The rebalancing can be done periodically, say, once a year or on reaching a trigger, say, a 10 per cent change in favour of one asset class.

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Never use money from the core to rebalance the satellite part. If the satellite part is not doing well, play to your strengths and stick to the core portfolio.

Shilpi Johri

Head, Arthashastra Consulting

"I prefer the fixed-ratio approach as it is easy to explain it to the client. However, rebalancing should not be done too frequently," says Jayant Pai, head, marketing, Parag Parikh Financial Advisory Services (PPFAS) Mutual Fund.

Variable ratio approach:
Under this, if the value of the stock portfolio changes significantly, the equitydebt ratio shifts to a new predetermined ratio. If the equity-debt ratio was 1:1 at the beginning, and the equity portfolio rises by more than 10 per cent, you can sell a part of your equity holdings and invest it in debt to bring the ratio to, say, 4:6.

Suppose your portfolio of Rs 20 lakh is perfectly balanced between equity and debt. Now, after some time, the equity portfolio rises to Rs 11 lakh and the debt portfolio to Rs 10.6 lakh. If you now want to bring the equity-debt ratio to 4:6, you can sell stocks worth Rs 2.36 lakh and invest the proceeds in debt.

As seen in the above examples, this approach requires much greater understanding of future equity market movements for arriving at the new ratio. If you cannot predict the market movement, stick to the fixed ratio approach.

Constant rupee value approach:
Under this, you keep the value of the stock portfolio constant, investing any appreciation in value in debt, or vice versa.

For example, if your equity portfolio is valued at Rs 10 lakh and it rises 10 per cent to Rs 11 lakh, you sell shares worth Rs 1 lakh and invest the money in debt. Similarly, if the portfolio value falls to Rs 9 lakh, you sell Rs 1 lakh worth of debt and invest in equities to keep the value of the stock portfolio at Rs 10 lakh.

Though the above discussed approaches bring objectivity to portfolio rebalancing decisions, experts advise a slightly more flexible approach.

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