MF Query Board

Readers are requested to send only one query at a time so that more readers get a chance. Have questions relating to any aspect of personal finance. Ask DSIJ at editorial@DSIJ.in and get your queries resolved. 

As presently the equity market is making new highs, should I reduce my equity exposure and invest in multi-asset allocation or balanced hybrid fund? - Karanveer Pathak 

Here it seems that you are trying to time the market. There is nothing wrong with that unless you are able to dedicate time and efforts for active management and are also able to digest the loss or losing profit opportunity by taking such calls. Given the level of the equity market and its valuations, shifting from equity to multi-asset allocation fund would be a bad decision. This is because in case of multi-asset allocation fund, there are very few funds that actually dynamically change their asset allocation. In order to get tax treatment of their fund-like equity, most of the multiasset allocation funds invest 65 per cent or more in equity even at higher equity market valuations. Hence it would be prudent to decide what asset allocation you are comfortable with and then maintain the same by periodical rebalancing. 

However, if at all if you wish to change your asset allocation dynamically then we suggest you to use sophisticated tools such as equity sentiment index – a DSIJ’s proprietary tool which would aid you take the asset allocation decisions. Or in case you do not have access to such a tool you can plot PE of the frontline equity index and take appropriate decisions based on the following graph. If the PE is trading above two standard deviation of its long-term average, it is better to book profit from equity and invest in debt. Similarly, if it is trading below its long-term average you can increase your exposure towards equity. 

A typical multi-asset allocation fund invests in equity, debt and gold. Nevertheless, each of these asset classes has a role to play in the portfolio. You can construct a multi-asset portfolio based on risk appetite. Despite high volatility, equity has potential to deliver maximum returns and is meant for wealth creation over the long term. On the other hand, debt offers relatively steady growth with much modest returns which can be slightly above inflation. Whereas, with gold historic trends suggest that it acts as a good hedge to your portfolio as it is not strongly co-related to equity or debt. Therefore, from a hedging perspective, some investors can have a certain allocation of gold in their portfolio.

I have read your story on how to have a core and satellite portfolio for equity funds. However, if I wish to do the same for my debt-fund portfolio how should I go about it? - Rajeev Rathi 

In a core and satellite portfolio approach, you typically have two major portfolios – core and satellite. Here, the core is usually the one which you cannot risk much and gamble on. When you look at investments in a core portfolio, you usually would not take much more risk than your overall risk appetite, have a well-diversified portfolio, and expect to beat inflation rather than the market. Generally, for your core portfolio you would be adopting a passive investment strategy.

Satellite portfolio comes when you have additional cash flows that you can take risk. Here the risk that you might be undertaking is quite higher than your actual risk appetite. Further, in order to earn potentially higher returns, typically you would be following an active investment strategy. Now the goal here is to beat the market returns and create wealth. Though for many investors satellite portfolio would form a smaller part of the overall portfolio, this does help you to boost your overall portfolio returns. Therefore, like equity it is quite possible to implement the same with your debt portfolio as well.

For the debt part of the portfolio, those investments would form part of your core portfolio that are well-diversified, which do not take too much of credit risk by investing heavily in lowerrated papers, mostly adhere to accrual investment strategy and do not take hefty duration bets, do not go overboard by very long maturity papers and generally maintain a fair amount of liquidity. Hence, investments with these kinds of traits should from part of your core debt portfolio. Mostly, short-duration funds, banking and PSU debt funds and corporate debt funds can be said to be the ideal fit for your core debt portfolio.

As for the satellite portfolio, like equity, these could include debt funds which take slightly higher risk by investing in papers of lower credit quality or take duration calls by investing in longer maturity papers when general interest rates are high. Credit play as well as duration play will help you derive extra returns. Therefore, for credit play, you can invest in credit risk funds and for duration play you can look at funds like gilt funds, dynamic bond funds and other medium to long-duration funds. Again, as majority of investors don’t like a lot of volatility in their fixed income investments, they have very low-risk tolerance. Hence, most investors might just stick to their core portfolio allocations and skip the satellite part altogether.