My current SIP in Mutual funds

In the past few posts I have discussed on several aspects of MF investments and also given an account of how my investments in MF has occurred over the years. Many people have wanted to know my current investments in MF, why I have chosen such a portfolio and my investment mechanism in these funds. Let me talk about it in this post.

As I said, we have been doing SIP since 2008 and these have been fairly regular. Over this period, I had given a lot of thought on what would be a good portfolio structure for me and my conclusions were ideally for a 5 fund portfolio, which I have shared with you in an earlier post. In 2013 when I was clear that I wanted to start my own consulting practice by end 2014, I wanted to take a fresh look at my portfolio and fix it for the next 2 years and maybe much longer. The funds I have chosen has been invested in Since December 2013 and the SIP will come to a closure by the end of this year. The idea is to let this investment grow over as long as possible over the next 9 years or so, till I am in the retired stage of life. Even at that point. I may or may not need to redeem this and the earlier MF investments that are in my overall MF portfolio.

I will outline the funds, my reason for selecting them, the performance over this period and my understanding of these and whether I am planning to continue with these after the end of this year. Note that all these funds are invested through Direct plans in the Growth option.

ICICI Pru Value Discovery Fund

  • This is the multi cap fund in my portfolio and I have been investing over it for a long time. The main attraction is how the fund manager is looking at newer opportunities to bet on established and little known stocks. More often than not he has got it right and this reflects in the results of the fund over the years.
  • During the period of this SIP, the fund has done reasonably well with an XIRR of 41%. Remember that for much of 2014 the markets went up and a standard SIP strategy was not the best way to go about it. Of course, that has been balanced a bit in 2015.
  • This is definitely a fund I will continue with in the future.

ICICI Pru Focused Bluechp Equity Fund

  • This is the large cap fund in my portfolio and I have also been investing in this for long. I like the fund as it follows the mandate it has well and takes calls on the sectors that have proved to work well. There are other good funds in this space but my vote is for this one for the long term.
  • XIRR for this fund over the SIP period is 21%. The rising markets in 2014 has definitely pushed up the acquisition price in this case but the XIRR will improve post the SIP getting over when markets run up higher. Some of its stock picks have not worked well but that will be the case with many other large cap funds.
  • Despite the options available in this space, my inclination will be to stick with this fund in my portfolio.

HDFC Mid-cap Opportunities Fund

  • This is the mid cap fund in my portfolio and I have also been investing in the fund for a long time. I like the fund as it works within its mandate and tries to look actively for emerging stories. Some of the stock picks over the years have really been stellar.
  • XIRR for the fund over the SIP period is close to 40%. The NAV has fluctuated between 19 and 39 Rs and this has obviously affected the purchase price adversely. Even then, the results are quite good.
  • There are other good options in this space but I will stick to this one for the long term.

DSP BlackRock Micro Cap Fund

  • This is the Micro cap fund of my portfolio and has been a long time favorite of mine. It has an aggressive approach to identify companies that have potential to do well in the future and their success rate has been surprisingly good.
  • XIRR for the fund over the SIP period is more than 50%. This is quite astonishing when one looks at the acquisition NAV ranging between 17 Rs and 42 Rs. Goes on to show the strength of their portfolio of stocks.
  • I will definitely stick with this and feel that every long term investor must have it in the portfolio.

ICICI Pru Indo Asia Equity Fund

  • I selected this fund for exposure to other markets and this was my first investment in it. The fund invests both in India and other Asian countries, thus trying to hedge some of the risks in the markets.
  • XIRR for the fund in the SIP period has been 25% which is fairly creditable.
  • As the fund has a pretty unique mandate, it is difficult to compare it with others. I will evaluate at the end of the SIP period as to whether I want to go on with it or not.

ICICI Prudential Dynamic Fund

  • Investment in this fund was more from a risk mitigation perspective as I was not sure about what directions the markets would take over the next 2 years.
  • XIRR of the fund has been 16%, which is fairly good considering the objective that it seeks to achieve.
  • I am fairly clear that I will not be continuing investment in this fund after the SIP period is over.

ICICI Pru US Bluechip Equity Fund

  • This is the primary international fund in my portfolio. I had invested in this fund earlier and chose this for the decent growth it has shown over the years, trying to balance the risks and the rewards.
  • The XIRR of this fund has been 12%, which is not surprising as the US markets have not moved anywhere as much as our markets. Acquisition NAV has fluctuated only between 15.5 and 18.5 Rs.
  • I will review the continuance in this fund beyond the SIP period but will probably stick to it.

The portfolio I have created is obviously suited to my needs and I do not recommend that you follow it without understanding all the implications. However, do get the structure of your portfolio correct to see that you are invested rightly for the long term.

In my next post I will talk about why I do not like investing in sector funds or balanced funds.

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My experiences with MF investments

In the recent posts I have covered different aspects of MF investing. Several people have requested me to share my own experiences with investing in MF and I will take that up in the current post. One caveat which is important to understand is that I am not recommending you follow my journey, If at all you want to follow my current investment approach.

My wife and I were introduced to Mutual Funds in a meaningful manner in 2001 when we had been in Chennai for a few years. Of course, I knew about MF before that, mainly through an erstwhile batch mate from IIM Calcutta, who went on to become the Fund Manager for Franklin Templeton. Many of you may know of him or have met him. However, in those days our investments were mostly in Debt instruments with a sprinkling of stocks. When the Financial Advisor explained to us about investment in MF as an alternative to stocks, it did not seem like a great idea at first. Remember that in 2001. the markets were down, there was general recession in the IT industry and the mood was fairly somber. Even then we decided to try out this new avenue in order to see how things transpired.

Our first investments were in Franklin Blue Chip and two other funds from their stable. The total invested amount in Franklin Blue Chip over 3 purchases was 50000 Rs, the average price in the beaten down conditions was about 10.5 Rs. Over the years, the fund has given dividends of 2.35 lacs and is current value is about 4 times our original investment. The CAGR is not given in the Franklin site and I am too lazy to calculate, but a good estimate will be between 18 and 20 %. I still hold my investment in this and have no plans of redeeming it. My wife has also done the same for the other two funds.

The other fund I invested in was Prudential ICICI Technology fund, courtesy my being from the IT industry. The NAV was only 3.27 Rs then but I was convinced it will improve over time. My total investment in this was 60,000 Rs and I got roughly 20,000 units for it. I have sold about 15000 units in 2006 with 100 % gains and hold the rest even now. The dividends from this has not been significant as the fund has had its ups and downs – total was about 35000 Rs. From the ICICI site I can see that the current XIRR value is 24.85 %.

Thus my initial experiences with MF has been fairly good. Even then I stopped investing further in these from 2002 onward. The main reason was that we had bought an apartment in Chennai with a loan of 15 lacs and my main focus was to pre-pay the loan as quickly as possible. I have never believed in the effectiveness of tax breaks through paying interest. Also, between MF and stocks I found that my temperament was more suited to stock investing, where I could be in control of things to a much greater extent. By 2005 We had achieved both the objectives of paying off the housing loan as well as building up the stock portfolio to a decent value. So while we continued to invest in stocks, there was some bandwidth available to start putting money into MF again.

The investment landscape had changed quite dramatically in 2005 as compared to 2001. The MF industry was booming, newer categories of funds had sprung up and every month there would be several NFO lined up. By that time I had got a regular agent and also had an ICICI Direct account which made buying rather easy. Both my wife and I bought into MF heavily during this period, both in terms of value and number of schemes. A lot of these were through NFO and all of these were one time purchases. Many of these have done reasonably well while some have not. We stopped this after about a year and sold off a few of the MF that we had bought through the NFO at fairly good gains. I do not have data on all of these investments but one fund from ICICI ( Exports & other services ) has an XIRR of 17 %. The main reason we stopped was our need to put more money into stocks, realizing that the markets were poised for growth.

We did build up a pretty good stock portfolio which went through the roof in 2007 and then crashed completely in 2008. This gave us time to reflect and we could see some merits in MF investments, even though these schemes had also been beaten down substantially. We organized our finances in 2008 and started investing in MF through SIP. My wife and I had separate portfolios and we chose MF from different categories. Our experiences in the stock markets had taught us that we needed to cover the market well for optimal returns as well as hedging the risks. Over the last 7 years we have been investing regularly in these two portfolios, with some changes in funds. For example, I stopped investing in HDFC Top 200 after 3 years as I realized that the returns from it were not commensurate with what the markets were potentially offering.

From 2013 end, when I got serious about getting out of regular corporate life and doing  something else, I have consolidated our portfolios to invest in 7 funds. The tenure of the current SIP will be over by this year and thereafter I plan to keep investing in the same funds but with a modified SIP approach that I wrote about earlier.I have also specifically invested in the ICICI Value fund series, mainly with an objective of earning some dividend income to boost my passive income stream.

While my experiences with MF has been largely good, I find it much more interesting and also rewarding to invest in stocks. For most investors, my advice will be to be in both, with a starting off in MF. A passive investor will find it easier to invest through MF and he should stick to it.

In my next post I will cover about my current MF portfolio and why I am investing in it.

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NFO from MF – have a balanced view

Normally when we are looking to start our investments in Equity Mutual funds we consider the universe of funds that have been in existence for a fair amount of time. Some financial planners will tell you that you should not even look at a fund which has not been around for at least 10 years and more. This makes sense at one level, after all with a fair amount of track record in place it is easy to see how the fund has performed in different market conditions. You will therefore have an idea on both the returns as well as the associated volatility and this will help you to select one appropriate to your needs.

What about NFO from Fund houses then, that are announced from time to time? Should you at all look at these or simply avoid them and stick to only established funds? Are there any situations where investing in an NFO makes sense? Before answering the questions let us take a look at why fund houses come up with NFO s in the first place? A large part of the reason is for them to gather more investments from existing and new investors of their funds. They can do the same for their old funds too, but from a marketing viewpoint there are many takers for something new that is packaged well. With the investor community extending to newer investors at a rapid rate this strategy has been reasonably successful.

The other reason for a NFO is a different mandate than what the existing funds are having. For example last year ICICI came up with several NFO for their Value Fund series. This series of funds had a mandate to invest in stocks that will appreciate in value over an investment period of 3 years. They felt that the markets were poised for growth in the medium term and wanted to make payouts to their investors either in form of dividends or capital appreciation. Note that this is quite different from the normal MF schemes that we invest in. There are other NFO s that get created due to specific situations in the market and these can be linked to a particular sector or market valuation itself.

Now coming back to the question of whether you should look at an NFO, an important thing to understand is that the money gathered through the NFO will be used for buying equities on the current market values. So, you may be buying these at less or more expensive prices depending on the market. The problem is when the times are good to buy any NFO will not find many takers. 2008 or 2011 would have been great time for buying but a bad time for launching NFO. Similarly 2014 had the markets at their most expensive point but a lot of NFO s were launched. The fundamental logic of having a lot of investment ability and flexibility to deploy all that money is ideal for a fund manager, if he can get himself into that position. Unlike existing funds, he is not stuck with the old choices, he can take a look at the next 10 years from now.

In my opinion, there will be very little point in investing in an NFO that is similar to a fund you are already holding. So if HDFC comes up with another Mid cap fund and you are already subscribed to a Mid cap fund, from HDFC or otherwise, in your portfolio then do not even look at it. Even if you are a new investor who is starting to build a portfolio, it will really make far greater sense to invest in funds with good track record, though the time frame need not be 10 years plus.

What about fund types that you do not have in your portfolio, say like sector funds. Here too, if you want to invest in a sector fund then stick to one of the existing funds. At a fundamental level though, I am against investment in sector funds as a diversified equity fund will generally meet all your investment objectives. This really leaves NFO s that are launched for special purposes and situations like in the ICICI case I mentioned earlier. You need to look into your financial objectives closely and decide as to whether the particular NFO makes sense for you. Do not be dogmatic about it, in the personal finance space rigidity of views is the worst possible enemy you can have.

My experiences with NFO has been rather interesting. In 2005 when I started buying MF regularly I was into one time purchases and bought these regularly for a period of 1 year or so. I would invest 25000 Rs in each NFO and chose 2-3 every month out of the numerous ones that flooded the market. These have not done badly in terms of returns, I sold most of them after 1-2 years but still hold on to a few. From 2008 onward I am investing in about 5 funds regularly with a combination of SIP and one time purchases. The only NFO I purchased recently was the ICICI Value fund series. This was with the specific objective of creating a passive income stream that would take care of my expenses.

As several people have wanted to know about my MF investments I will share it in the next post.

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MF portfolio construction – One time purchases vs SIP

As we have been discussing in the posts concerned with the construction of a MF portfolio, SIP or a modified version of it is the most normal investment mode of purchasing MF. This makes logical sense from 2 aspects – firstly, you are unlikely to have a supply of money frequently that will allow you to make a large one time purchase and secondly, it is a good practice to spread your purchases over a period of time to take advantage of varying purchase prices as a way or lowering risks.

But what if you had enough money to invest one time in your MF portfolio? How should you go about it then? Let us say you had 3 lacs available at the beginning of April 2015. So, do you buy into your portfolio with the entire amount in April or do you buy into your portfolio with 12 equal monthly purchases of 25 K each. For many people this question may not arise as the money supply is just not there, but if you were to take that constraint out then which will be a better approach? Most people will probably say that you keep your money in a Liquid fund and do an STP of 25 K per month etc. The assumption here is if you buy over a period of time then your unit prices will somehow be lowered.

This assumption however, is true only in the case of a falling market. If the markets are going sideways or they are rising then a one time investment will actually make more sense than a SIP. If you take different years as example and calculate the returns of a one time investment versus regular SIP then you will see there is very little difference in the actual outcome. Try this out using different calculators available in the other blogs, I do not want to repeat it here. The other thing that happens with a one time investment is that all your units purchased get the maximum time available for growth. Again, this is a great idea in a rising market and a not so good one in the falling market.

One of the things I feel investors should do is to not be completely mechanical about their SIP investments. Most of us decide on an amount, give a bank mandate and leave it at that. Nothing wrong with it if your available investment is relatively fixed for a couple oh years and you do not want to change anything. I prefer being in control of it myself so that I can vary the investment depending on the market situation and my availability of money. So, while I have regular SIP for the funds in my portfolio, I also make one time purchases in these funds based on the market situation. Of late, of course, I have started following the approach that I have detailed on another post talking about how to do a modified SIP.

The availability of money is another factor that one needs to consider and this is obviously connected to the life stage the investor is in. For people in the age group of 25 to 40, regular family expenses along with a home loan EMI and other asset purchases often means that the amount to be invested is relatively defined. Exceptions can be in the events like yearly bonuses or variable pay. For such investors a regular automated SIP along with some specific one time purchases when extra money is available will be the way to go. In the latter stages of working life however, the situation changes quite a bit. Home loans get over, children go off to college and their expenses get funded through redeeming other financial assets and incomes tend to peak. It is not unusual for families to have high surplus for investment at this stage. One way to use this surplus will be to bump up your MF portfolio through one time purchases of reasonably high amounts, while keeping the regular SIP going, another can be to invest aggressively in direct stocks so that you build up that portfolio now.

If we believe that our markets are going to go up in the long run then the earlier we are able to invest in MF portfolio the better for us. Compared to your stock portfolio an MF portfolio is more time sensitive, though both will have greater chances of doing well over the long run. My suggested strategy will therefore be to keep investing in MF through SIP and one time purchases till you have covered your investment plans for that part and thereafter put more money into stocks.

One of the other issues in the MF portfolio construction is the question as to whether you should be investing in NFO. Most people will say no and I think the understanding is fallacious. Will cover this in my next post.

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MF portfolio construction – how to allocate your investment

In the previous posts we have covered the structure of the MF portfolio you should be having and how to select the specific funds in the different categories. You will also be having an idea of how much to invest in MF monthly, based on the goals you have set for yourself. In case, you are needing more clarity on this aspect read through the two series on Financial Planning and Goal Based Investing that I have in the blog. Each of these have 10 posts and cover the topics exhaustively.

For the purposes of this post, let us assume you need to invest 20000 Rs per month for the next 20 years in order to meet all your goals. Of course, MF portfolio will not be your only source, you will be having a debt and a stock portfolio too. Now the question becomes, how should you allocate this amount into the 4 funds that you have chosen from 4 different categories? Well, an obvious way will be to just put 5000 Rs in each fund monthly and be done with it. This is actually not a bad strategy and can be followed by most people. Regular investment over a long period of time will make your money grow substantially, if not in the most optimal manner. For people who want to keep it really simple, I will recommend this. Decide on the funds, set up an automated SIP and be done with it.

What if you are a more aware investor and have some preferences for particular categories of funds? In this case you will need to channel more of your money to your preferred category. In general the large cap and multi cap funds will have lower risk and volatility as compared to the mid cap or small cap funds. If you are a conservative investor and do not want to deal with volatility beyond a point then put more of your money in Large cap and multi cap funds. On the other hand if you are an aggressive investor and are willing to stomach some volatility in the hope for greater growth then more of your investments should go into the mid cap and small cap funds. Note that these amounts can be fixed too in terms of percentage allocations and an SIP set up.

Now you may also be an evolved investor who wants to ensure that his investments are being used in the most optimal manner. In this case you will need to vary your investments with a linkage to the market. I have already explained a mechanism for doing this in an earlier post about how to do a modified SIP and you may follow that or son other means. There are two basic ways of achieving this – you can either do a standard SIP and add more investments manually at lower levels of the market, or you can have a truly variable SIP where you decide on the monthly allocation based on the market situation. My recommendation is that only serious investors who are willing to track the markets and make their investments accordingly should get into this mode. For all others, a regular SIP can also work quite well.

So, to summarize for a fixed investment amount the following are your investment allocation options:-

  • Fixed SIP with either equal allocation to all 4 categories or different allocations to the 4 categories.
  • Variable SIP where you decide monthly on your investments, all adding up to your total monthly investment. Any surplus money can be allocated as explained above.

What happens when I can increase my monthly investments over the years, as will normally be the case? For the fixed SIP you follow the same % allocations, the amounts will obviously increase. For variable SIP, you again follow exactly the same mechanism as before, albeit with the increased amounts.

Now for many people, the amounts available for investment initially will be low and they will grow over a period of time. For example a person starting off his career may be able to invest only 5000 Rs in his first year of working and increase it to 20000 Rs or so by the time he reaches his 5th year. In such a case you need to follow the sequence I am suggesting:

  • Depending on money availability first invest in large cap fund and then multi cap fund.
  • With time build up your investments amounts in these 2 funds to the level you need eventually.
  • Start investing in the mid cap and small cap fund now and build up these investments as above.

Many people have asked me the question whether they should continue their investments if the markets are falling in a sharp manner. The answer to that is an unequivocal “yes”. The whole idea of success in equity investments is to procure financial assets at a low price and a falling market allows you to do just that. Your fixed investment in SIP will buy you more units when the markets fall, if you can afford to put more money you should do so.

An opposite situation will be when the markets are rising over a period of time. Here too, as a regular investor you should just stick to your investment allocation. You are now buying units at a greater price but over the long term these units are anyway likely to appreciate in value. If you are an evolved investor then you can reduce your investments for the time being, keep liquid cash or debt available and bring this investment to buy more units when the market turns. Note that though this strategy is financially sound, it does require good understanding of the markets and a fair bit of time.

All this is good but should you invest one time in MF if you have some surplus money? How does one time MF investment compare with SIP as a strategy? I will address this issue in my next post.

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MF portfolio construction – selecting the funds

We saw how to choose the categories of Mutual funds for your portfolio in the last post. While the categories can vary with individual situations, I do believe that the 4 types of funds along with an international fund will be the best way to go for most people. Remember that you are choosing the portfolio for long term investment and will be doing an annual review of it. So, the idea is not to get stuck in the process of selecting funds for long, but to decide on them and start investing.

Just to drive home the point, there are fundamentally 2 reasons for the 4-5 fund portfolio structure that I am suggesting. The first one is on coverage of the market. Stock performance can happen in any part of the market and you do not want to limit your participation to a narrow area. For example mid caps may have done quite well lately but you are unable to predict how they will keep performing in the long run. If you have only one mid cap fund then your portfolio lacks diversification and is therefore prone to more risk. Also, you may be giving up on serious growth opportunities in other parts of the market. The second reason for such a portfolio structure is the flexibility it gives you in investing. Read through my post again on the modified SIP way. With this portfolio structure you can vary your investments in each of the funds based on how that part of the market is performing at the given point of time.

With that out of the way, let us look at how you can arrive at the individual funds that you want to invest in. Even within the categories there are a plethora of options and most people get confused in trying to arrive at the “best” fund to invest. You will have many people coming up with calculators and historical data along with all kinds of ratios to help you in selecting a fund that is best for you. I find this is completely futile exercise for 2 reasons. Firstly, no matter what method you come up with, you are never going to be a match for professionals who are trained and do this for a living. Just like some random person cannot come and do your job better than you, so cannot you do it better than the people in the industry. There is no point in trying to reinvent the wheel. If you are suspicious of ratings then, by all means, try to understand how the rating has been arrived at. But honestly, I find it ridiculous that you open up an Excel sheet and populate with some data, hoping to find some magic deliverance though high flaunting financial jargon that has little meaning. A MF scheme will do well if it invests in the right stocks, no amount of Excel jugglery can tell you that.

The second reason why an involved exercise in choosing a MF scheme is meaningless is this – no matter how much data you analyse with whatever tools, it is all in the past. The MF itself warns you, of course prodded by SEBI, that you should not project future outlook based on past performance. So why would you even try to do that.This is also the reason why you should not look at the ratings from different websites as the gospel truth.

So how do you go about selecting the specific funds? The answer is amazingly simple and you just need to follow these steps below.

  • For each category look at the top rated funds from any website that you trust and whose rating methodology you understand. I have found VR online to be quite reliable but there are several other sites that will work too.
  • Make sure that the top ratings are not only determined by the last 1 year returns etc. So avoid settling for the Top 5 funds of the month etc. You are looking for long term investment and not just a short period bonanza.
  • Once you have made a shortlist of 3-4 funds in each category, you can narrow these down further by these:-
    • Reputation of the fund house. Ideally you should go for large ones that have been around for a long time. An exception can be a niche fund house, if you are convinced of their credentials. Personally, I have always been comfortable with Franklin, HDFC, ICICI and DSP BR.
    • Longevity and track record of the Fund manager. It will be nice to have a fund manager to have been with the fund for a long time, preferably 5 years plus. He should have also had a successful track record with this fund or earlier funds that he has managed.
    • The AUM of the fund. While this is not a definitive criteria, in general a larger AUM does provide a fair deal of flexibility to the Fund manager as to how he wants to deploy the money.
    • The trend of previous year returns, though this will generally be good for the top rated funds.
    • Check the current fund holdings to satisfy yourself that the fund is sticking to the mandate that it has. While all fund managers must have some leeway to improvise, you do not want to buy a large cap fund that is taking calls on mid cap stocks.
  • Repeat these for all categories of funds that you want to have in your portfolio. By this time you will have 1-2 funds in each category. Pick any one of those, it will not really make any meaningful difference if you have done the steps right. In any case, we will do an annual review to see how the funds are doing.

If you are already having a portfolio then I suggest you do 2 things immediately. Firstly, align your portfolio to the suggested portfolio structure that I wrote about in my earlier post. Secondly, do a basic check of whether you are in the right funds by checking these against the criteria mentioned in the above steps. If you see that you are not aligned in your portfolio or do not have the right funds make a change now. Loyalty is an admirable quality in life but not when you are selecting MF.

So we have now reached a point where you know how much you need to invest monthly ( from Goal based investing ), how should your portfolio be structured and what funds you are investing in. The next question to come up is how should you allocate your money to the different funds.

I will be answering that in my next post.

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MF portfolio construction – choice of fund categories

In order to build a Mutual fund portfolio, the first thing you need to decide is how much is your final outcome and what is the level of investment you can do regularly. If you are not clear about this search this blog and read the posts on Financial planning and Gal setting. The next aspect is what type of fund you must invest in which is the topic of this post.

Now at a very basic level we can classify funds by their types of investments namely Equity, Debt and Balanced. As I have explained earlier the role of debt MF is really relevant when you are trying to build a passive income stream. Your PF and PPF investments will normally cater to all the debt allocation that you need. For a variety of reasons I do not like Balanced funds and I will cover this in a later post. So the question in the post really boils down to what types of Equity MF should you invest in? Let us examine this in some detail.

There are many categorization of Equity MF – you could classify them by the sizes of the stocks that they hold ( large cap, mid cap etc), you can classify them by their sector holdings ( Pharma, Banking etc), some funds are operating based on market levels ( Dynamic funds, PE based etc). Depending on your particular situation, all of these funds can be relevant to you at some point of time in your investment life. My individual belief though, is that the two asset classes debt and equity should be kept separate and asset allocation of re-balancing is best done by the individual investor.This being the case, I avoid any of the funds that take calls based on market levels to balance between debt and equity.

Many of you would have noticed the high returns from sector funds such as Pharma or Banking. As is clear from their nomenclature, these funds have concentrated holdings in a particular sector so if the sector is doing great, the fund returns will be spectacular. This, of course, works the other way too and the NAV levels can drop significantly when the sector goes through a bad time. If you want to invest in these funds then you will have to live with an increased volatility compared to other diversified mutual funds. However, volatility is not the main reason I do not invest in these funds. As you know, I am an ardent supporter of the 3 portfolio strategy – Debt, Stocks and MF. If I want to invest in a particular sector I would like to do so in companies of my own choosing. They will form part of my stock portfolio. For example, I have several stocks from the Pharma, Banking and Technology sector. Therefore an investment in sector funds will simply be an overkill for me.

For me and most other investors investing in diversified equity MF will meet all our needs. Within that space you need to look at funds based on the size of companies that they hold namely, large cap, multi cap, mid cap and small cap. While the returns, risks and associated volatility will be different for each of these categories, I believe for a robust long term MF portfolio it will be important to invest in all of these. The allocation you want to do in them will depend on your long term return expectations and the risk/volatility you are prepared to take. My own investments are evenly spread in these 4 types of funds and my overall experience has been fairly good so far.

Finally there is the question of whether you should be investing in international funds or not. Ten years back i would have probably not seen any real need for it. In today’s context though the world economies are much more closely linked and interdependent. In such a scenario investing in international funds can be a good hedge against any serious corrections in the domestic market. I therefore think one can invest in funds based on US, Japan and Europe in that order. Do not go overboard on this, a small allocation is sufficient. From my own perspective, I invest in US and Japan funds regularly now but for much of the time before I did not have these in my portfolio.

So in order to summarize selecting the types of MF these guidelines can be used:-

  • Avoid Balanced funds as debt and equity investments are best kept separate.
  • Avoid sector funds as they focus only on one part of the market. The only reason to invest in them will be if you do not have a stock portfolio, but even here good diversified funds are adequate.
  • Avoid funds that take calls on market levels such as Dynamic funds, same logic as Balanced funds.
  • Diversified equity funds are the best way to go. Choose funds falling under large cap, mid cap, multi cap and small cap category. This will give you a 360 degree coverage of the market and will suffice in most situations.
  • Have some exposure to international funds to take advantage of the opportunities and also for hedging.

In my next post I will talk about how you can build a robust long term MF portfolio with these choices.

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Understanding Diversification & its implementation

Diversification is a word that is often heard in the world of investment. Financial planners will tell you that you need to have a well diversified portfolio to reduce your risks, meaning that in case one asset does badly the impact can be cushioned by other assets doing well at the same time. We have all heard the adage – Do not put all your eggs in the same basket. Examples of diversification are available to us from all over – students try for multiple colleges and entrance exams in a variety of streams to ensure that they get admission somewhere. This is also an example of diversification.

In this post I wanted to outline the different kinds of diversification that you may want to consider for your investments. As always, I will try to relate it to my own experience in this aspect.

The most important kind of diversification is Asset Class Diversification.

  • Investments can be in Equity, Debt, Real Estate, Gold, Commodities, Currency etc.
  • Allocation will depend on the asset class and the time frame for which you want to hold it. Assets like Equity and RE are typically long term in nature. Currency and commodities will be for much shorter term.
  • I believe that for most investors, Equity and Debt investments allocated properly will be enough for all needs.
  • My personal investments are purely in Equity and Debt asset classes. I own an apartment but that was not acquired with an idea to invest. The small amounts of Gold and Currency I have are for consumption.

The next important type is Investment Vehicle Diversification within an asset class.

  • Within Equity you can choose your investment as Stocks or Equity MF.
  • Within Debt you can choose PF, PPF, FD, Debt MF etc
  • Make sure that your investment vehicles broadly complement each other.
  • I have investments in both Stocks and equity MF. I also have Debt investments in PPF and Debt MF.

The third important type is product diversification within the investment vehicle.

  • Within stocks you may want to invest in large caps, mid caps etc. Similarly you may want to invest in some specific industry sector such as Banking, Auto and Pharma etc.
  • Within MF you can invest in Large cap oriented MF, Mid cap oriented MF etc.
  • I’ll write about portfolio creation in future posts but my portfolio recommendation for MF has 4 types of Funds – Large cap, Multi cap, Mid cap and Small cap.

The fourth important type is geographic diversification based on location.

  • Main markets you can look at are US, Europe and Japan. There are funds available for each markets.
  • I invest in funds for US and Japan in a regular manner and for Europe in spurts.

Within the MF space itself you can further refine diversification in the following manner:-

1. Diversification among different Fund houses.
2. Within the same Fund house, diversification in different Fund managers.
3. Diversification in funds having different investment styles.

When you create a portfolio, diversification is an important consideration both for optimizing returns and mitigating risks. This is the reason why I am worried when people tell me that they need to invest in only one good MF or just in a particular sector of the economy like the large cap Banks. This may work well in the short term but is a fundamentally flawed idea, never mind who does it and how successful he has been.

In my future posts I will cover creating a portfolio of stocks and MF where diversification will be a key aspect.

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Why you must be in direct equity

In several of my blog posts, particularly in the series “Equity as an asset class”. I have explained the need of investment in equity. To restate the argument in simple terms, returns from equity and Real estate are the only ones having the potential to beat inflation over the long run. Given that RE investments are complex to both buy and sell and need a fair bit of money at one go, investment in equity is an obvious choice. The next question is what should be the investment vehicle for equity investments. Mutual funds and stocks are two of the possible vehicles that you can go for.

For most people who are investing today, Mutual funds are the preferred route of investment and I think this is a good idea. To begin with the investor is unaware of the complexities of the market and investment in MF is a safe way to start. Regular investment through SIP is also a good idea as long as we understand the limitations of SIP as an investment mode and have taken care of those. I have explained this in some detail in the last few posts of mine in this blog.

In this post I want to talk about investing in direct equity. Among retail investors the practice of investing in stocks is rather low and one of the main reasons is the active discouragement that is prevalent from most quarters. We Indians have an opinion about everything, irrespective of our intrinsic knowledge of the relevant subject, and this is more so in the case of cricket, movies and the stock markets. Instead of going into a long discussion about the normal objections on investing in stocks and why they are not necessarily correct, let me simply give my personal take and example on each of these.

  • Stocks are inherently risky, you should invest in MF through SIP which has a lower risk.
    • Understand that equity MF and direct equity both have the same underlying assets and therefore carry the same risks. I have already explained in an earlier post about the limitations of standard SIP.
    • Even though you can know about the MF holdings you are in no position to decide on the calls the Fund manager takes. In direct equity you have an advantage of investing in exactly the company that you want to invest in.
    • My personal experience has been that the risks of loss is the same for both in a falling market but the possibility of greater returns is more in the right stocks when the market rises rapidly.
  • Stocks lose more money as compared to MF when there is a market crash,
    • Now, there is some truth or half-truth in this. Individual stocks can lose far more than MF in a falling market. However, the reason for it is that MF scheme is a portfolio of stocks and cannot be compared rightly with a single stock. If you are comparing a portfolio of stocks to the MF scheme the outcome will roughly be the same.
    • My experience in the 2008 crash was that both my stock and MF portfolio lost by nearly the same amounts.
  • You need to be an expert in Financial markets to invest in stocks.
    • This is simply not true, though you do need to understand some things about markets and businesses in order to select the right stocks to invest in.
    • There is a lot of good information available, you just need to use it in the right manner.
    • Most of what people will tell you about reading Balance sheets etc is actually rather limited in use. There are better people than you doing the analysis and you can simply use their work without reinventing the wheel.
    • Most of what I have learnt is on my own, without attending any workshops or similar things.
  • A Fund manager can take the right calls on his portfolio and you cannot.
    • This is simply not true as a fund manager has limited flexibility due to redemption pressures and the need to deploy money when he gets it. We as individuals are only accountable to ourselves.
    • There are many glaring examples of Fund managers having taken the wrong calls.
    • The fund manager undoubtedly has access to more resources but that does not make his task any easier.
    • My own CAGR in stock portfolio has comfortably beaten that of my MF portfolio over a long timer period.

So, it may be possible to invest in stocks but why should you be doing it. A one word answer is “growth” but let me try and give a more detailed one:-

  1. As I have said before, you need to have 3 portfolios – debt for your financial base and to ensure that you are not forced to sell equity at the wrong time, MF to plan for meeting your financial goals and Stocks, to give you the kicker returns that your portfolio needs.
  2. If you build a robust portfolio of stocks the chances of losing money is very little over the long term but the potential returns can be substantial.
  3. As a country, we are going to have a high phase of growth over the next 2 decades or so and several companies will be benefited by it. Investing in some of these companies will have potential for the investor to create serious wealth.
  4. Good companies pay significant dividends along with bonus etc and this can be a strong element in creating a passive income stream.
  5. It is tough to think of financial independence or early retirement without the returns from a stock portfolio.
  6. You need a stock portfolio even during retirement as it will continue to grow in value and pay you dividends.

I hope that many of you have now stopped wondering about whether you should buy stocks and thinking now as to how you should go about it. I will cover about how to build a good stock portfolio in the next post.

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SIP – A modified version

The good response that I received yesterday on my two posts corroborated the popularity of SIP as an investment avenue for most people. Some were upset that I was trying to suggest something against their deeply held belief, others tried to convince me that the way SIP is currently being done is the only way. However, most people wanted to know more about how SIP can be used in a better manner to improve upon what is happening today.

As I said, I have been doing SIP for a few years now and have shared some of my experiences in varied market conditions. It is not necessary for me to do SIP for 15 years to get an understanding, our markets have gone through the entire gamut of possible ups and downs in the last 8 years itself. At an overall level normal mode of SIP has worked well for me. XIRR for most of my funds are in excess of 20 % which is quite good. However, one needs to understand that much of it has been due to the 2014 effect, when the markets rose sharply. Now, that is the nature of equity and financial planners will tell you it is normal but I do not think it is a good strategy to depend on exceptional years for your returns.

So, how should one approach SIP? Well, for starters any equity investment return is based on only 2 factors – how much you buy when and at what price, and how much you sell for what price and time. As we are mainly doing this for goal based financial planning, the goal time frame is when we need to worry about selling. Thus the entire strategy boils down to when should I buy, how much and at what price. Obviously, if I can buy at a lower price it is beneficial to me. Now, most people will extol the virtues of standard SIP here by saying that as we do not know how the markets will behave, it will be better that we just invest the same amount every month. As I have discussed before this is not an optimal solution at all.

The simplest strategy of a modified SIP is as follows – continue to invest in your regular SIP but keep some available cash to take advantage of any sharp corrections in the market. Let us say Nifty is at 8500 today and you are investing in a Large cap fund through SIP of 5000 Rs every month. There will be days in the next few months, due to news flows and other global events, that will see sharp corrections in the Nifty, maybe to the extent of 100 points or so. You can simply invest more in those days to take advantage of the lower NAV s. Note that this is a low risk strategy as you are buying units at lower cost as compared to your regular SIP and therefore your unit cost will be lowered. Over a period of time this will have a good impact on your returns. The trick here is to set up some benchmark triggers – decide on how much you should buy when Nifty falls by 50 points, 100 points and stick to it.

Now the above is all very well if you have extra cash at all times but that may not be the case. Also, it does not address the basic issue – bulk of your investments are still going by the standard SIP and therefore the issues outlined in the earlier posts remain. In order to derive a more robust strategy we will need to understand the market trends to some extent. Now, I am not saying that all of us will become experts in predicting the markets, I definitely do not consider myself as one. At the same time it is possible to observe some basic trending in the indices and take actions such as the following:-

  • In a declining market over a period consider increasing your SIP allocation or simply buy extra units separately.
  • In a rising market decrease your SIP allocation and keep the cash for purchasing at the right times.
  • If there is a prolonged sideways market, consider increasing SIP allocation if the general indicators are for a strong up move and decrease it if a serious down turn is projected.
  • Remember that while it is difficult to predict index levels accurately, the broad trends can normally be predicted. You will not always find the predictions to be correct but the chances are fairly good.
  • In any case, your whole idea is to buy more units when the NAV is lower, so you cannot go very wrong in this.

Most people will now say, this is all very fine in theory but how can we implement it in real life? Let me share with you an implementation of SIP that I am now looking at. This was a post that I had shared in AIFW group in Facebook and it had generated a fair bit of discussion. Read this carefully to understand how it will work. I quote :-

Just sharing my plans on how I intend to do my monthly investments in ICICI Focused Blue Chip for the next 18 months. The investment date is 5th of every month.

1. Base Nifty is taken in the range of 7800 to 8200. If on 5th of a month Nifty is in this range I will invest X.

2. For every 100 point drop in Nifty from the range I will increase my investment by 1000 Rs. So if Nifty is 7500, my SIP for the month is X + 3000. If it is 7700 then my investment will be X + 1000.

3. For every 100 point rise in the Nifty above 8200 I will decrease my investment by 1000 Rs. So if Nifty is at 8500 I invest X – 3000 etc.

4. Every 3 months I will check the 100 DMA value of Nifty. If it is very different from the base figure of 8000 then I will change the range. I do not think this will be the case soon.

5. When I need less money for SIP I will put the excess in Debt, could be Liquid funds or even Arbitrage funds. If I need more money I will pay from any surplus I have OR redeem from Liquid funds.

6. I have taken Nifty as the index as the fund is a large cap fund. For funds in other categories one will need to work with the appropriate index.

I am convinced that this will reduce my unit cost of purchase over the next 18 months.

You can use the same framework but work with numbers that are comfortable for you. For example you may feel that Nifty will range around 8400 which may well be the case now. This was written some time back. Similarly, you may want to change the variable amounts or the scale. The important point is to understand the frame work, the absolute numbers will depend on individual situation.

Can I say with confidence that is the best way to go about things – surely not. Is this better than the plain Vanilla SIP that most financial planners and experts advise you to follow? Absolutely and I can guarantee better results.

In conclusion, regular SIP will work well in a market that is having a downward bias. Our markets are not such and therefore you are actually buying an asset whose price is increasing over time. When there are ways of dampening the acquisition cost of this asset you will definitely be better off when you follow such a strategy. Implementation mechanism is obviously important and once you start doing it you will get it right, maybe after a few iterations.

I can already see several people objecting to this by saying that I am trying to time the markets and how it is a bad thing to do. Well, not really but I will address that in a different post.

Interested readers may pls follow my blog on email by clicking on the relevant button on the right hand panel. I will shortly be stopping the practice of posting the links in different Facebook groups. Following the blog will ensure you get intimated whenever there is a new post.