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Mutual Funds Investment

To Mutual Fund Performance analysis of the 3 sample portfolios given here. Investing in Mutual Funds for the long term is an ideal way to save money and grow it with the objective of multiplying one's savings after taxes, at more than the increasing cost of living or inflation. Investing in these funds are very suitable for those who may have money available on a periodic or monthly basis from salaries or other incomes and would like a better return on their money than bank interest.

Of course, any investment plan must consider your individual requirements, and are usually a mix of fixed income investments such as bank deposits, and financial instruments such as shares of companies, mutual funds and exchange traded funds (ETFs) that track specialized sectors including gold, and possibly precious metals like gold and silver and real estate (property).

Click here to scroll down to sample mutual fund portfolios.

Before investing in any financial scheme you should research the potential risks and benefits of all investments you intend to make and consult an experienced and qualified financial adviser. Finally, it is your money and your decision, and your risk, responsibility and reward.

A Mutual Fund is basically a financial trust that pools the savings of many depositors together for a common financial goal. The fund company issues 'units' much like shares, that represent an equitable right in the assets of the fund.

The unit holder can buy and sell units of the fund quite freely, like shares of companies at a price that is recorded and updated daily by the fund house. This price represents the underlying composite value of all its holdings, adjusted for expenses the fund house incurs for the business.

As the value of the underlying assets of the fund increase, so does the value of the units. If any of the constituent companies issue dividends, the fund also gets the same benefit. By buying the units of a particular fund, one essentially buys a share in a composite basket of financial instruments.

While constructing a portfolio, it is advisable to get a good mix of different fund houses and strategies, and to diversify the industries relevant to the funds holdings. This reduces the impact risk of a sectoral under-performance. It also reduces the upside potential, but there is an added level of safety--the return may be less, but it would be stable over a period of time.

Investment into the individual mutual funds should never be done in one lump sum, but spread over a period of a few months so as to take advantage of the inevitable periodic price drops of fund units. This is known as 'averaging' the costs of the units. One can use a Systematic Investment Plan (SIP) to invest regularly. Your bank, the fund house or online trading service provider will give you the details--it is a simple process of giving instructions to your bank to regularly pay into the fund account monthly, quarterly or fortnightly as may convenient for you.

Sample mutual funds portfolios according to risk criteria. You can use this as a guideline for your own research.

Aggressive Investor

Conservative Investor

Moderate Investor

Core Investment - 60%-70%:

HDFC Top 200 [5*] (Large & Mid Cap)

Reliance Equity Opportunities [4*] (Multicap mandate; currently maximum midcap, and has some unconventional picks

Reliance Regular Savings Equity [4*] (Multicap mandate; currently maximum Mid Cap, and Debt)

Secondary Investment - 20% - 15% (investment in either one, or both):

IDFC Premier Equity [4*] (Midcap)

Birla Sun Life Dividend Yield Plus [4*] (Midcap)

Strategic Investment - 20% - 15% (investment in either one, or both):

DSPBR Micro Cap [5*] (Small Cap, with greater risk-reward)

HDFC Mid-Cap Opportunities [5*] (Mid & Small Cap)

Core Investment - 70%-80%:

Franklin India Bluechip (Large Cap) [5*]

HDFC Equity (Multicap mandate; currently maximum Large Cap) [4*]

Reliance Regular Savings Balanced [5*] (Hybrid Equity, Mid Cap with Debt)

Secondary & Strategic Investment - 30%-20%:

HDFC Prudence (Hybrid Equity, Midcap with Debt)[5*]
AND/OR
HDFC Balanced (Hybrid Equity, Midcap with Debt) [5*]

IDFC Premier Equity [4*] (Midcap)

Core Investment - 75%-90%:

Franklin India Bluechip (Large Cap) [5*]

HDFC Prudence [5*] (Hybrid Equity, Midcap with Debt)
AND/OR
HDFC Balanced (Hybrid Equity, Midcap with Debt) [5*]

UTI Dividend Yield [4*] (Multicap mandate; currently maximum Large Cap)

Reliance Regular Savings Equity [4*] (Multicap mandate; currently maximum Mid Cap, with Debt)

Secondary & Strategic Investment - 25%-10%:

IDFC Premier Equity [4*] (Midcap)

HDFC Mid-Cap Opportunities [5*] (Midcap)

Funds rated by Value Research

The portfolio selection criteria is basically divided into a bulk Core investment, a Secondary investment and a Strategic investment.

The Core investment of 60% to 90% of your mutual funds portfolio should consist of relatively stable large cap or large and mid cap holdings, or flexible multi caps, including some funds that may have some debt exposure.

The Secondary and Strategic investments should account for 10% to 30% of your portfolio, with the Secondary funds having a significant debt exposure and may be a mix of large and mid caps or multi caps. (Multi caps have a flexible capitalization mandate and can shift their investment focus to take advantage of market scenarios and are not bound to remain invested in a particular capitalization zone.)

The Strategic investment aspect may consist of more risky or volatile funds that may add extra profits over the long run. Typically these are funds of micro-cap, small or mid-sized companies, where growth opportunities may multiply greatly in the long run.

The mutual funds typically should also have major exposure to different sectors of the market to add to the diversification factor of your investments. This diversification across business and industry sectors is essential to minimize risk exposure to any one sector.

Further, one's holdings should be spread over different fund houses and fund managers. As their outlook on the market sectors may be somewhat different this adds an additional diversification factor of safety for your investments.

For example, HDFC Prudence and HDFC Balanced funds operate in the same space--hybrid equity with more than 60% equity exposure, and both are oriented towards mid caps, managed by 2 different managers. However, their major sectoral orientations are different. HDFC Prudence's top 3 sectors are Finance, Energy and FMCG (fast moving consumer goods), while HDFC Balanced fund's top 3 sectors are Finance, Services and Energy.

A note on small and micro cap company investments
About 12 years ago I invested in a stock of a micro cap company, Carnation Nutra-Analogue Foods Ltd.

This company made a margarine product marketed as a healthy replacement for butter called Nutralite, and the 1 rupee face value share was trading between Rs. 1.10 and 1.30 after the company had declared a dividend of 60 paise.

I bought at that time and post dividend my net cost was Rs. 0.70 for a share of par value of Re. 1. It was a thinly traded stock but its financials looked good and the buzz was that some larger company might buy it up and promote the essentially single product company.

Single product tiny companies either sink or swim fairly fast, so when the stock hit Rs. 13 in a few months, I sold out my holdings for a net gain of 18 times my investment. I could have sold out only enough stock to recover my original investment cost, but I was not comfortable holding a small unknown company's stock for the longer term. There were 2 other considerations--A thinly traded stock is by nature volatile and I did not believe that the financials at that time supported the increasingly exaggerated valuations. Second, it seemed that some message boarders on Moneycontrol.com were bidding up the stock among the boarders to possibly benefit themselves.

In 2006 Cadilla Healthcare bought a controlling interest in Nutra-Analogue Foods. In 2008 the company name changed to Zydus Wellness when it's stock was was trading at around 150, and today, 2 years later, it is trading at Rs. 600 and at a mind boggling price/earnings (PE) ratio of 50. It still sells Nutralite very successfully along with other health products--SugarFree, a sweetner, and EverYuth skin care products.

The stock that cost 70 paise 12 years ago has increased in value by over 850 times. Note: I am not sure whether the Carnation stock translated completely into the new entity or there was a dilution of shares. Either way, anyone who acquired Carnation stock when it was trading in single digits and held on to it would have made a huge gain since then--certainly better than my 18 times investment-- which gain was quite fine for me.

Exciting as this may seem, it is not at all a normal event. However, it illustrates the appreciation potential of small and micro cap companies and also the inherent risks attached to such companies. This sort of research is better left to experienced fund managers who have the resources to get more detailed information from the company management, and a knowledge-based conviction for staying committed to their research and vision.

It is always better to take profits rather than gamble on an uncertain position. For every Nutralite there are fifty companies where you would lose your entire investment.

Buying units from a fund house

For our purposes we would always buy the units of mutual funds from the secondary market and not when there is an IFO or initial fund offering.

The reason is, that we do not know what will be the investment success for a new fund. (Units of mutual funds can be purchased form the fund house directly, through some banks or through an online trading portal such as ICICI Direct.com, Share Khan, SMC Online and others.)

For example a specialist gold ETF (exchange traded fund) entering the market will buy physical gold, while other gold funds (such as BlackRock) may buy shares in gold companies, gold miners or other foreign funds having exposure to gold in various ways. If the fund house buys these at a high price and then there is a market correction in the value of gold which happens frequently, the value of the units can drop drastically. When this happens, usually the investor panics and sells out for a loss thinking that the whole mutual fund business is very risky.

Balancing Profit and Loss Risk
For existing mutual funds there is a track record of past success over a number of years and we can see what has been the thinking of the fund manager and his fund performance. We must look for a balance between risk and reward and our capacity to tolerate the risk when we decide upon a fund to invest in.

Types of mutual funds suitable for investment
If your goals are to protect your savings and increase them in time, then you may consider investing in 3 types of funds--debt funds, equity funds, and hybrid funds which include debt and equity both.

DEBT FUNDS:Debt oriented mutual funds have some exposure to relatively safe debt paper issued by governments (state and local), companies, and corporate bodies including banks. The return on this is not as high as from equities but there is a safety factor of holding good quality debt which is considered less risky.
However, given the recent disclosures about the financial scams happening in government owned companies in the financial and banking sectors, one may find it is better to invest in a hybrid fund that also invests in some debt. Debt funds are useful only for corporate investors who need to park company funds for short periods of time and look for a better return than banks. In our view debt funds are not useful for the individual investor.

EQUITY FUNDS:Equity funds invest mostly in equity shares of companies, and may also have a very small exposure to debt. Shares of companies are classified as small cap, medium cap and big cap. This refers to the total market capitalization (market cap) of a particular company.
Market capitalization (market cap) means the market value of all the shares of the company as valued by buyers, based on what they are prepared to pay for the shares as per the last traded value. This value would change on a daily basis depending on the market valuations.
Capitalization of companies are valued as Large cap, Mid cap, Small cap depending upon these valuations. The criteria we follow is that the Large cap universe comprises of the highest 100 stocks by capitalization, Mid caps are the next lower 100 stocks--101 to 200 by capitalization, and Small caps are those that list at between 201 to 300. Micro cap would be the companies lower than 300 in such a list.

HYBRID FUNDS:
These are mutual funds that are a combination of debt and equity funds, holding different proportion of debt and equity depending upon their stated objective. Generally, these funds have a good balance between risk and return.
In our view, these funds are quite suitable for a decent exposure to the debt market without needing to invest separately in a debt fund. This view is contrary to most financial advisories but our logic is that the 20%-30% debt in hybrid funds is an adequate safety margin.
Also, some of these funds are flexible in their asset allocation profile within their mandate, and are know as 'Multi-cap' funds.
This means they can choose to get in and out of the capitalization categories as they see opportunities. Thus at some point they may have more of the mid caps and small cap funds in their portfolio, and at other times they may have more large caps. This gives the fund manager a lot of leeway for maximizing potential profits.

Fund Performance over the past year

NOTE:The values calculated are for a year from a particular day. These values will change on a daily basis as we calculate for the year, hence these figures are only indicative. In reality, an investor will be making investments on a periodic basis when sometimes the fund unit values will be fluctuating.

The combined return on such periodic investments will be different than indicated because some units would have been held for a longer time while others for a shorter time. The returns given here help to look at the performance of various funds over different time periods. The chart can be looked at for shorter periods or periods up to 5 years.

Chart from Value Research Online

There are other specialist funds that invest in different sectors of the economy such as pharma, infrastructure, energy and so on. This means that these funds are subject to greater fluctuations of price if the companies of that sector do not perform well at any given time. In general, one should stay away from such funds unless one is willing to take more risk.

Therefore, it is best to be invested in mutual funds that have a diversified portfolio of companies across different sectors and businesses so that a fall or collapse in any one sector may be balanced by gains in another sector.

How to decide in which funds to invest
One of the commonest mistakes of a new investor is of investing in many funds thinking that he is 'diversifying' and reducing his risk. What ends up happening is that the investor ends up duplicating investment objectives or increasing his exposure to the equity of many companies across the different mutual funds.

This last is specially counterproductive, giving mediocre results, because as the shares held are so small proportionately, that they will have a very small impact on the overall picture. So the investor will not benefit much from any gains of any one company. An increase in the number of funds in one's portfolio of between 12 to 20, can end up creating an individual portfolio of over 100 different companies.

We have been tracking mutual fund performances for many years now, and find that one of the best information resources available is valueresearchonline.com. There is a lot of information and research available there.

A sample portfolio of mutual funds according to risk criteria is given above. Click here to scroll up to the table.

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