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Playing The Market: Don't Get Stumped!

| 4/19/2012 9:00 PM Thursday

There are many situations that investors often fail to understand while they invest. Hemant Rustagi explains some of these for the better understanding of our readers.

KEY POINTS:

  • As the tide shifts in favour of a particular segment, the performance of funds focussing on that segment improves. However, the skill of the fund manager and the fund house’s investment philosophy can make a difference to the performance.
  • While there is no hard and fast rule with regard to the level of cash as a percentage of the overall portfolio size, most funds keep it at up to five per cent in normal circumstances.
  • Even the most experienced of fund managers find it difficult to time the market successfully on a consistent basis. No wonder then, that when common investors try to do this, they invariably find the markets moving in the opposite direction.

The mystique that surrounds the stock market attracts investors to it. Although many of them get attracted to the stock market by the prospect of high returns, the attendant risks shake them up from time to time. Apart from the anxiety caused by a natural phenomenon called volatility, investors often face issues and situations that require a proper understanding of the markets to tackle them. Here are some of these issues and what they mean for investors:

Why does performance differ so much?

Investors often get confused when they see a huge gap in the performance of different funds within the same asset class. This gap can generally be attributed to factors such as the investment philosophy of the fund, the skills of the fund manager in terms of stock picking and the type of fund, i.e. Diversified, Large-Cap, Mid-Cap or Small-Cap fund.

For investors who put money into a variety of funds, this is a situation they face from time to time. This is because different segments of the market perform differently at different times. As the tide shifts in favour of a particular segment, the performance of funds focussing on that segment improves. However, the skill of the fund manager and the fund house’s investment philosophy can make a difference to the performance, even in a segment that is not doing well.

Should I worry about portfolio turnover?

Portfolio turnover reflects how frequently securities are bought and sold by the fund. A 100 per cent portfolio turnover rate indicates that the portfolio was completely turned over in a year. Portfolio turnover generally varies with the market conditions and investment category.

For an MF investor, it is important to know that an aggressive equity fund is most likely to have a high turnover rate. Certain debt funds also have high turnover rates.

A fund with a high turnover rate will incur higher transaction costs as compared to one with a lower turnover. Unless superior stock selection provides benefits that offset the additional transaction costs, the returns for investors are likely to be impacted in a fund that has a high portfolio turnover.

Why do fund managers keep cash?

Fund managers generally keep cash in hand to take care of redemptions. Besides, as the money comes in from new investors or in the form of dividends, it accumulates in cash before it can be invested. In other words, a fund manager keeps cash in hand not to benefit investors but to facilitate the management of the fund.

While there is no hard and fast rule with regard to the level of cash as a percentage of the overall portfolio size, most funds keep it at up to five per cent in normal circumstances. However, there could be occasions when the fund manager may keep the cash at a much higher level. This could be for various factors, such as the cash generated by the selling of securities to book profits, volatile markets that may force the fund manger to wait for the market to settle before investing or huge inflows over a period of time.

Why does the market move in the opposite direction?

This is a situation which investors often face. This happens when one tries to time the market. It is a well-known fact that even the most experienced of fund managers find it difficult to time the market successfully on a consistent basis. No wonder then, that when common investors try to do this, they invariably find the markets moving in the opposite direction.

While it is a fact that even a long-term investor needs to book profits, the key to success is to have a proper strategy in place. One such strategy is to rebalance your portfolio periodically. Rebalancing is a method by which the allocation to debt and equity are brought back to the original level. This is important as one asset class grows faster than the other. Rebalancing becomes necessary because investments must be made to achieve best results at an acceptable level of risk. By failing to rebalance one’s portfolio, one violates this premise and is exposed to unpalatable levels of risk.

Hemant Rustagi
CEO, Wiseinvest Advisors

 

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