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Factors to keep in mind while investing in mutual funds

While most investors focus on tackling market volatility, there are a few other factors too that can impact the final outcome of their investment process. Hemant Rustagi, CEO, Wiseinvest Advisors says like volatility, these factors can also be tackled by following the right investment strategy.

Hemant Rustagi        Last Updated: April 24, 2014  | 18:26 IST
Hemant Rustagi

One of the key factors that makes investors wary of investing in equity market is its volatile nature. In fact, volatility in the stock market tests even the most seasoned equity investors. For mutual fund investors, tackling volatility can be even more challenging as many of them take time to understand the nuances of equity investing.

Although volatility is the most feared factor for investors, it is possible to minimise its impact on one's portfolio by investing for the long-term and following a disciplined approach. While most investors focus on tackling market volatility, there are a few other factors too that can impact the final outcome of their investment process. Fortunately, like volatility, these factors can also be tackled by following the right investment strategy. However, if these are ignored, they can make a dent in the portfolio returns over time. Here are some these factors and how one can tackle them:

TYPES OF FUNDS IN THE PORTFOLIO 

While the level of exposure to equity as an asset class is important on the risk-reward matrix, it is equally important to keep an eye on exposure to different market caps. Market capitalisation of a company signifies its market value, which is equal to the total number of shares outstanding multiplied by the current stock price. The market cap has a role to play in the kind of returns the stock might deliver and the riskiness or volatility that one may have to encounter from it. For example, large companies are usually more stable during turbulent periods and mid cap and small cap companies are more vulnerable.

Each one of us has a different risk profile, time horizon and investment objectives. Our portfolio mix should reflect this If you cannot decide on the right mix, the right way to begin would be to consider those multi-cap funds that invest predominantly in large cap stock and have a small presence in mid and small cap stocks.

If you are an experienced investor, you may have some aggressive funds like sector, mid-cap, opportunity or thematic funds in your portfolio. Although by selecting the right sector and holding these funds in the right proportion can enhance your portfolio returns, at some stage they may not suit your requirements. For example, if you need to pare your exposure to equity funds for reasons such as completion of your time horizon and rebalancing your portfolio, you must reduce your exposure to aggressive funds which in turn can reduce the volatility in your portfolio.

While making changes in the portfolio, when required, can benefit you in more than ways, making any selling decision on some immediate urge can backfire. Equally important is to remember that as an investor you have the cushion of your fund manager weeding out the over- priced stocks and laggards out of the portfolio. So, don't be in a hurry to exit from funds that may under-perform for some time.

SIZE OF THE FUND
It is commonly believed that a fund can become victim of its own success. In other words, it can become too unwieldy to manage efficiently. However, it is important to look at the fund size in the context of its nature and investment style. A fund's performance can suffer in case it outgrows its investment style.

For example, a mid-cap fund where the success depends on how effectively the fund manager does the stock picking, the large size of the fund may force him to make certain compromises in terms of the investment approach.

However, the fund size does not matter for some of the fund types. For example, it is much easier for a debt fund manger to manage a large fund compared to an equity fund. Considering that the size of the debt market is much bigger than the equity market, there are plenty of options available for the fund manager. Therefore, if you get worried about the size of the fund, don't be in a hurry to exit from it.  Make sure you exit from it only if its performance is likely to be affected by its size. 

THE URGE TO BOOK PROFITS EVERY NOW AND THEN

Even those investors who invest with a defined time horizon get tempted to book profits every now and then. In fact, this is one the reasons for investors not benefiting from the true potential of this wonderful asset class.

Most investors follow this strategy mainly with the hope that they will exit at higher levels and re-enter at lower levels. This urge gets further compounded during the periods when the markets turn volatile. This is nothing but an attempt to time the market.

You need to know that even the most experienced fund managers can't time the market perfectly on a consistent basis. Hence this strategy of booking profits say every now and then can ruin your chances of achieving long-term investment goals. Remember, an equity fund with an established long-term performance track record is likely to give you better returns on a consistent basis.

OVER-DIVERSIFICATION OF THE PORTFOLIO
If you are one of those investors who believe that having a large number of funds in the portfolio can reduce risk, think again. Mutual funds themselves are a diversified vehicle and hence there is no need to have too many funds in the portfolio. In fact, there are chances that you may end up having similar funds in the portfolio that may behave exactly the same way when the markets go up and down. In other words, they neither allow you to benefit from up trends nor provide any additional protection during downturns. Moreover, it becomes cumbersome to track the portfolio and as a result a number of non-performing funds continue to be a part of the portfolio. Needless to say, it affects the long-term performance of the portfolio. Therefore, avoid having too many funds but make sure that different segments and strategies are appropriately represented in your portfolio.

(The author is CEO, Wiseinvest Advisors.)

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