What drives your mutual fund portfolio?

Mutual funds have the potential to fulfill a wide variety of investor needs, risk preferences and investment objectives. However, it is important that selections are made after ascertaining the kind of asset allocation that would suit one’s requirements and time horizon. While this process can be a little tricky, considering that one must know how different asset classes co-relate with one another, as well as how to select suitable schemes out of the options on offer in different categories, the right combination of schemes in a portfolio can do wonders for achieving the desired results. Apart from the suitability, it is equally important to opt for funds that have been consistent, in terms of following their investment strategy as well as their performance. Therefore, it pays to spend time in putting together an effective portfolio.

As is evident, the selection process plays a significant role in the level of success one can achieve from one’s mutual fund portfolio. However, inspite of taking all precautions, one may still have to face situations wherein even the most consistently performing funds may become erratic during certain periods. While at times, this may happen due to an error of judgment on the fund manager’s part, investors must know that often such a situation may arise because of the market behaviour. Hence, it may not be wise to abandon the fund in a hurry.

Remember that if a fund loses ground in a falling market and falls in line with its benchmark index, it should not be much cause for concern. On the other hand, if a fund goes down when its peers are yielding positive returns, this should be taken as a warning signal. This is why the key to measuring performance is to compare a fund with its peer group. For example, while analysing the consistency of a fund that invests in a particular segment of the market, i.e. a mid-cap fund, one needs to consider the level of volatility that the segment itself may be witnessing. However, the skills of the fund manager and the fund’s investment philosophy can ensure that the fund stays less volatile.

Once investments are made, monitoring the performance on an on-going basis becomes essential to ensuring success. At the same time, having made a decision based on thorough research, one needs to give the fund manager enough time for the fund to perform. However, once it is proven that the fund’s performance is slipping, one should not hesitate in getting rid of it. By getting rid of non-performing funds and re-investing the money in schemes that have a better quality portfolio and track record, one can enhance the chances of improving returns over time. Don’t forget, getting emotional about non-performing investments or waiting endlessly in the hope of recovering losses can be a fruitless exercise.

An appropriate level of diversification in the portfolio is another aspect that requires attention. Diversification does not always mean owning 10 schemes or so. To determine the right level of diversification, one has to consider factors like risk profile, portfolio size, type of funds and allocation to different asset classes. It is critical to pay attention to the level of risk one is willing to take to meet one’s expectation of returns.

Risk tolerance should also be addressed from two perspectives: financial risk tolerance and emotional risk tolerance. Investment professionals often define risk as volatility; in other words, how much one’s investments will rise or fall in a given period. Individuals usually define risk as the potential to lose money or not meet their goals. Every equity fund investor must know how comfortable he/she will be if the portfolio goes down 5 per cent, 10 per cent or 20 per cent for a certain time period. It is equally important to know as to how long can one hold on to failing investments – three months, one year or three years.