Preparing A Perfect Portfolio
It does not make sense to simply invest available money into all kinds of mutual funds without understanding the objectives of making such investments or choosing the right funds to create a balanced portfolio that can provide the best returns
Meet Mark Matheus who has been investing in mutual funds for the last eight years. Though he has adopted the systematic investment plan (SIP) route to invest, he has also invested in lump sum. All these investments were made under different pretexts. For example, he started a few SIPs to fulfil some of his financial goals. Next, whenever he got yearly and quarterly bonuses, he invested in funds that were the flavour of the season primarily to diversify or add zing to his portfolio. Most times he ended up investing in a sectoral fund or broader market funds. Sometimes he could not resist unsolicited advice to invest in a fund. Now, at the end of 2021, he has more than 30 funds in his portfolio.
This is much more than one would expect to make a portfolio. The problem with such bloated and over-sized portfolios is that it becomes next to impossible to keep track of your entire investments. Investing is only a part of the entire investment process. Monitoring them and making periodic adjustments in terms of either rebalancing or timely exiting is another crucial aspect of investment. Most investors who jump in and invest without much thought and in response to market conditions will eventually find that this kind of an approach does not work out well. Something that often feels right in the short term is mostly wrong in the long term. Further, the ‘do it yourself’ kind of investors will tend to invest in multiple funds so as to diversify their investments.
So, within large-cap funds they would be investing in more than two funds since large-cap funds are required to invest 80 per cent of their corpus in top 100 companies by market capitalisation. Thus, such portfolios have investments from the same universe with overlapping investments that don’t do much for diversifying the portfolio.
Therefore, as a sensible investor it is important that you should do a thorough review of your portfolio at least once a year. Even if the present volatile times might not be the ideal time to make such adjustments, keeping track of your investment will help you to identify the winners and losers.
Consolidating a Portfolio
Know what you are holding and why are you holding them. Before you start the process of consolidation of your portfolio, you need to know what you are holding. Consider all your mutual fund investments and map them with the reason why you had invested in them. This will help you to decide if they still contribute meaningfully to your entire portfolio. There could be cases where you may have invested in multiple mutual funds belonging to the same asset class based on a friend’s recommendations and another based on your office colleague’s suggestion. Many investors suffer from the misguided view that with each additional mutual fund in the portfolio, their risk is mitigated.
1) The Art of Diversification: Diversification is an important aspect of your investment portfolio. Nonetheless, if you want to diversify your investments, don’t start buying unless you have a plan. While you can invest across market capitalisations you should not duplicate investments with a diversification perspective. For example, for an equity portfolio, one fund from each broader category such as large-cap, mid-cap and small-cap would do. Evidence suggests that diversification works only till a certain point beyond which your portfolio becomes over-diversified and an over-diversified portfolio will not give you optimal returns.
Having too many funds also poses tracking issues, which is an extremely important activity post investing. Therefore, take a critical look at how individual funds have performed and how they are contributing to the performance of the entire portfolio. If a fund has consistently underperformed its peers and benchmark for a while – say a year or more – consider replacing it with another fund from the same category considering that you have a single fund from this category. If you have another fund from the same category, check its performance and retain it if it is performing well while exiting from the earlier fund.
2) Identify the Temperament : Access your risk-taking ability. Not all the best performing categories or funds may be your cup of tea. You must understand what kind of an investor you are. Once you have identified your type, you must make investments accordingly. For example, you may be a conservative investor or one who has an aversion to risk and yet a majority of your investments are inclined towards high-risk categories such as small-cap-dedicated funds or sectoral funds. This will lead to an over-exposed portfolio towards instruments that might not suit your investment temperament. Accordingly, decrease the exposure of your portfolio to equity funds. The idea is to be invested across limited funds that provide the desired exposure and diversification simultaneously which are in alignment with your goals.
3) Macro to Micro : After going through the earlier two points, you would now get a hang of funds that need to be weeded from your portfolio so as to make space for new mutual funds. Next, the micro part of your portfolio consolidation is to select appropriate funds for your portfolio. Conduct comprehensive research and dig down deep into the fund’s performance from various perspectives such as rolling returns, outperformance against peers and benchmark, expense ratio, fund house stature and other relevant factors before actually adding a fund to your portfolio. Do not fall for the recent trends of the funds you are targeting. Look out for long-term trends and then make an informed decision. Select a fund best suited to your risk appetite and financial objectives.
4) Redeeming and Re-Investing : Once you are done with your primary research of funds that need to be exited and the funds that need to be entered into, there are other aspects that need to be considered. While exiting a fund there are certain costs involved, two of them being exit load and tax. Therefore, assess these costs and do your analysis if it makes sense to exit now or not. While making mutual fund investment it is always advisable to invest in a direct plan instead of a regular plan. A direct plan has lower expense ratio compared to a regular plan and these plans generate better returns in the long run.
Quality over Quantity
Quality works over quantity in most places and a portfolio is no different. While it is always advisable to leave your investments alone, at times it requires complete overhaul, especially if it is becoming unmanageable and you are not able to keep a track of your investments. There is no thumb rule on the number of funds you should be holding in your portfolio. It is better to have lower numbers that gives you good asset allocation and help you to achieve your financial goals. Assigning the same funds to different goals is one of the ways to keep a check on the number of funds in your portfolio. At the most you can have 12-15 funds in your kitty, including both your core and satellite portfolio. These funds should be from different asset classes including equity, debt and commodity. This will allow you to monitor them regularly and rebalance your portfolio efficiently.