Building an Equity Mutual fund portfolio from scratch

In some of my blog posts this year, I have written about how one can build a Mutual fund portfolio with the new categories that SEBI has come up with. However, I still get a lot of enquiries on how investors, especially new ones, should go about building an MF portfolio. In this post let me show you how to build one from scratch.

Before we get into looking at the types a starting investor should invest in and what funds he can look at, let us first recap the types of equity funds SEBI has come up with.

  • Multi cap fund
  • Large cap fund
  • Large & Mid cap fund
  • Mid cap fund
  • Small cap fund
  • Dividend yield fund
  • Value fund / Contra fund
  • Focused fund
  • Sectoral/Thematic fund
  • ELSS

For an experienced investor all of these fund categories may have some use or the other in their portfolio. However, if you are at the starting point of your investment journey then my recommendation will be that you only look at 3 fundamental categories along with an ELSS fund for tax saving for the first 5 years or so. In fact, I will want you to forget the ELSS if you have enough money to invest in your MF portfolio and some good debt investment like PPF separately.

Ok, so without further ado, here are the fund types you need to have in your portfolio and some of the schemes which you can choose from.

  • Large cap fund
    • HDFC Top 100
    • ICICI Prudential Blue chip fund
    • ABSL Front Line Equity fund

 

  • Mid cap fund
    • HDFC Mid cap opportunities
    • Franklin Prima fund
    • DSP BR Mid cap fund

 

  • Small cap fund
    • DSP BR Small cap fund
    • Franklin India Smaller companies fund
    • HDFC Small cap fund
 Let us now see how you can create a portfolio from scratch. I will only outline the process here and if you are interested you can go through the various posts in my blog to get more details on the concepts and reasoning behind those.
  1. Based on your life goals, identify the time line for each major goal and understand how much of financial commitment they would require at those times. For example the college education of your son may need an amount of 40 lacs in 10 years.
  2. Once you know the time lines and the amounts, look up an SIP calculator and calculate the SIP amount you will need to invest every month. Use a return of 12 % to be on the conservative side. In the above example, to get 40 lacs in 10 years time at 12 % XIRR, you will need to do a monthly SIP of 17388 Rs.
  3. Do the above for all your goals and add up these amounts. This will give you the total monthly investment you need to do all your financial goals comfortably.
  4. Now look at your age to decide on your risk taking ability and therefore the ideal asset allocation. My suggestion will be the following :
    1. If you are less than 35 years old put 40 % in Mid cap funds, 35 % in Small cap funds and 25 % in Large cap funds.
    2. If you are between 35 and 45 years old put 30 % in Mid cap funds, 25 % in Small cap funds and 45 % in Large cap funds.
    3. If you are above 45 years old put 20 % in Mid cap funds, 20 % in Small cap funds and 60 % in Large cap funds.
  5. Once you have decided on the allocation, just pick out one fund out of each category and start investing. Do not worry about which fund as all of these are good and in the long run it does not really matter which one you have chosen. However, try to make sure that you have funds from at least 2 fund houses, preferably 3.
  6. A sample selection can be ICICI Prudential Blue chip for Large cap, HDFC Mid cap Opportunities for Mid cap and DSP BR Small cap fund for Small cap.
  7. Once you have decided on the monthly amounts, just set up an automated SIP and let the money get invested every month.
  8. You will need to do an annual review but that is a different story altogether.

I hope most people would have found this useful. Recently I was approached by a reader who wanted me to create a portfolio for him. I will share this in another post.

 
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Close ended NFO’s open now – should you subscribe?

Over the last few years and especially in 2017 and 2018 many of the Fund houses have come up with a slew of close ended NFO’s. These come with a variety of themes and associated terminology. For example ICICI calls them Value Fund series, Sundaram calls them Micro cap series and Axis calls them Equity advantage series. In this post let us look at why these are in vogue now, what are the pros and cons and finally whether it is a good idea to invest in them.

The first issue is relatively simple to answer : new products get developed based on the likelihood of their success. With a lot of retail and institutional buyers pumping in money, there is always a demand for newer types of funds to invest in. For fund houses, it is an opportunity to have a specific charter which may not be possible to fulfil through their regular funds. For example, one of the ICICI value series funds only wanted to invest in Pharma and IT sectors as these were beaten down significantly over the last six months or so. Now this could be done in one of their existing funds too but for a fund manager to churn the portfolio by selling stocks that are doing well is not always an easy decision to take. Using fresh money in taking such calls is relatively simple. The trend started by end 2014 or so with ICICI and has now percolated to several others.

What are the pros and cons of such funds? Well, for one the mandates here have a lot more clarity compared to a vanilla large cap or mid cap fund. The fact that it is close ended, normally for 3 years, means that the fund manager has time at his disposal to take the calls he wants to take. On the flip side you will not have access to your money for 3 years and this is a problem unless you can definitely do without it for this time. A greater problem may be your inability to shift in case you are not happy with the performance. From my viewpoint, I do not see both these issues as a serious one. Firstly, you should be investing in equity for a much longer term than 3 years. Secondly, the Fund manager is way more qualified to deal with short term performance issues.

Let me now give some details of an investment that I made in one such fund. While the experience may not be repeated for all funds, it does offer certain insights:-

  • I purchased ICICI Prudential Value Fund series 2 on 6/12/2013. Invested amount was 2 lacs in the Dividend option.
  • The idea was to get some regular income as I planned to go for my consultancy practice sometime in 2014.
  • Though it was a 3 year fund, it has now been rolled over and will mature on 31/12/2018.
  • So far total dividends have amounted to 2 lacs
  • Current value of the fund is nearly 2.1 lacs

I think it can be said quite safely that this worked out quite well. In fact, I have invested in several follow up NFO from ICICI. Apart from ICICI I have also tried out Axis, Birla Sunlife, Sundaram and UTI for close ended funds. From a personal perspective it works well for me as I got tax free income and also growth from it. With the change in taxation, the returns will be lower but it is still a better bet than most of the other options.

You should be investing in these funds under the following situations:-

  • You have some income requirement every year. Instead of doing FD you can go for close ended funds with dividend option. Note that the dividend is not guaranteed.
  • You have a goal after 3-4 years. This is ideal for such situations. However, in such a case choose the Growth option.
  • You have come into some money and do not want to decide on allocation for 2-3 years as you may need the money then. Go for the growth option here too.
  • Make sure you understand the mandate and therefore the associated risk profile. A micro cap series from Sundaram will obviously be more risky as compared to the Value fund series of ICICI. However, the rewards will vary in a similar trend too.

If you are interested in these funds after reading this post, do consider the following NFO’s that are ongoing now :-

  • ICICI Pru Pharma, Healthcare and Diagnostics fund
  • ICICI Pru Bharat Consumption fund – Series 3
  • Tata Value Fund – Series 1

All of these funds have interesting themes and are likely to do quite well over the 3 year period. Personally I have put 1 lac in each of the ICICI funds.

People having surplus money and waiting to invest in some suitable avenue should take hold of this opportunity.

MF schemes with highest assets – should you invest in these?

I have been away from writing the blog for a while as my children are at home now and we had been to Bali for a vacation. It was nice to see that several readers have inquired as to when I am going to resume writing the blog. With all the interesting things happening in the markets I think this is a good time to start writing again.

Over the past few months the SEBI mandated categorization of MF schemes have now happened, thus bringing a lot of standardization for the investors. I was looking at the MF schemes that have been the most popular over the years. Now, just because the schemes have been invested in it does not mean that you must do so. At the same time there is a lot of value to these schemes being supported over the years by investors.

The following 6 schemes have the highest AUM, all of them above 20000 crores:-

  • HDFC Prudence fund
  • HDFC Equity fund
  • HDFC Mid Cap Opportunities fund
  • ABSL Frontline Equity fund
  • Kotak Select Focus fund
  • SBI Blue Chip fund

Should you be investing in these funds? For that it is important to look at the following issues:-

  • Fund manager credentials and longevity are normally good for all these funds.
  • With a larger AUM the flexibility of the fund manager to make quick changes according to the market situation is limited.
  • The mandate of the fund becomes critical in these situations. With the SEBI definitions in place a pure large cap fund will find it difficult to generate differential returns.
  • It will be imperative to look at the past records of these funds especially for the last year or so where the markets have gone through a volatile period.
  • While most of the existing investors can remain invested in these schemes for some more time the real issue is whether new investors should get into these or not.

Based on the above, it will be fair to say that both HDFC Prudence as well as HDFC Equity have really not performed well compared to both the Benchmarks and Peer group funds. If you are looking at a large cup fund you will be better advised to stick with the ABSL or SBI variant. However, for investors with a longer term time horizon, Kotak Select and HDFC Mid cap will be significantly better options.

Of course, there are several other great schemes where the AUM is not as high as these six funds but these are doing as well or better. I have some posts on these in my blog and you can go through them to build your own high performance MF portfolio.

Mutual fund schemes suggested by experts

After the recent categorisation of MF schemes as mandated by SEBI, there is a lot of confusion among investors as to whether they should continue with the earlier investments or revamp them altogether. I had written about some funds you can consider for your long term MF portfolio. Recently I got to hear the views of some experts about the MF schemes of their choice.

As I have already written about the considerations in choosing an MF scheme for the long term, I will not repeat them here. The funds suggested below are from experts appearing in CNBC TV18 programs and have a long pedigree. The basis of selection was long term performance and this will typically be 10 years and above. So without any further ado, here is the list of funds :-

  • In the large cap space consider the following funds:
    • ICICI Focused Blue chip fund
    • ICICI Nifty Next 50 fund
    • ABSL Front line equity fund
  • In the multi cap space consider the following funds:
    • ABSL Equity fund
    • SBI Multi cap fund
  • In the small cap space consider the following funds:
    • Reliance Small cap fund
    • DSP Small cap fund
    • SBI Small cap fund
  • If you are looking at hybrid funds for lower volatility consider these:
    • HDFC Balanced fund
    • ICICI Balanced Advantage fund

In order to build a portfolio of 3-4 funds you can just select one from each of these categories and start investing in them regularly.

A long term MF portfolio in the changed regime

As I have said before, I support the initiative taken by SEBI in reducing the clutter of the MF space. The definitions of fund types as well as the regulation on what kind of companies they can invest in the different schemes lends a lot of transparency. In this post let me try and outline an MF portfolio which may be suitable for most investors.

In conceiving this portfolio I have looked at a time horizon of 20 years. This is the kind of time frame where you can take certain amount of volatility in your stride and benefit from the long term India growth story. The types of funds and the possible schemes that one can look at investing are given below. Note that you can mostly look at Direct schemes in order to keep the expenses low. There is really no point in giving off 1 % or more in expenses annually, over such a long time period.

Without much more ado then here are my suggestions:-

  • Large cap funds can have 20 % of your portfolio. Choose from below 
    • ICICI Blue chip fund
    • SBI Blue chip fund
    • Nifty ETF funds
  • Multi cap funds can have 20 % of your portfolio. Choose from below
    • DSP opportunity fund
    • HDFC Capital Builder fund
    • Mirae India Equity fund
  • Mid/Small cap funds can have 30 % of your portfolio. Choose from below
    • HDFC Small cap fund
    • L & T Emerging business fund
    • DSP Small cap fund
  • Tax Savings funds are only if you need to use them to exhaust your 80 C section. In case you have enough to invest otherwise do not go for these. Choose from below
    • IDFC Tax Advantage fund
    • ABSL Tax Relief-96 fund
  • Thematic funds are for the more risk oriented investors. Choose from below
    • IDFC Infra fund
    • Mirae Consumer fund
    • ABSL GenNext fund

Note that while I have suggested some allocation here, how much you should invest in each depends on your stage of life and also investment horizon. For example if your risk appetite is low then go light on the Mid/Small cap category and definitely avoid thematic funds. On the other hand a person with good understanding of the markets and high risk appetite can invest significantly in these two categories.

The good thing is all fund houses are giving you an opportunity to exit the current holdings. How do you go about this and recast your MF portfolio along with investing well for the future? I will cover this in my next post.

Investing in Mutual funds after the changes

The recent changes in regulations brought in by SEBI for the MF space is a welcome step. For too long Fund houses have gone about misleading people with naming funds in an attractive manner and investing in a manner different from the stated mandate. This had meant that several investors were investing in funds in a manner which was different from their real objective. In the changed circumstances, how should you go about investing in MF? Let me try to address it in this post.

Firstly, if you are an existing investor you will have to do a one time stock taking of your portfolio. You can do it in the following manner :-

  1. Check your portfolio value against the overall goal that you have and see where you have reached. For example, your FI goal in current money may be 5 crores and you may be at 1 crore. If you have different portfolios for each goal then you will need to do it for each portfolio. Remember that multiple portfolios is really a sub optimal way of investing and ideally avoided.
  2. Use a SIP returns calculator to check what is the XIRR you will need to have for your portfolio from this point in order to reach your goals. In the above example, you need 3 crores more as your current 1 crore will also grow in the next 15 years. If you are investing 50000 Rs a month and have 15 years to your goal of FI then you need an XIRR of 14 %.
  3. Based on the required XIRR you will need to reorganise your future investments in the following manner:-
    1. If the required XIRR is between 8-10 % then put 30 % in Balanced funds, 40 % in large cap funds and 15 % each in Mid and Small cap funds.
    2. If the required XIRR is between 10-12 % then put 20 % in Balanced funds, 40 % in large cap funds, 20 % each in Mid cap and Small cap funds.
    3. If the required XIRR is between 12-14 % then put 10 % in Balanced funds, 30 % in Large cap funds, 30 % in Mid cap funds and 30 % in Small cap funds.
  4. If the XIRR needed is more than 14 % then you need to increase your investment levels. It will be injudicious to make any plans with a return expectation higher than 14 %.

Secondly, if you are just starting off on your investment journey or are in the initial stages of it then look at the following portfolio:-

  1. 20 % in large cap funds
  2. 20 % in multi cap funds
  3. 20 % in mid cap funds
  4. 20 % in small cap funds
  5. 20 % in International funds

Over a long period of time, say 20 years or more, this all weather portfolio will serve all your investment needs well and hopefully take you to a FI state. Of course, you will need to review it annually and churn the funds or tweak the percentages every 3-4 years if it is needed.

Bottom line – have realistic XIRR expectations, look at a long time horizon, review every year and change things in 3-4 years as needed. That is really all you need to do.

ICICI Bharat Consumption fund – should you invest?

Over the last few years and especially in 2017 many of the Fund houses have come up with a slew of close ended NFO’s. These come with a variety of themes and associated terminology. For example ICICI calls them Value Fund series, Sundaram calls them Micro cap series and Axis calls them Equity advantage series. In this post let us look at why these are in vogue now, what are the pros and cons and finally whether it is a good idea to invest in them.

The first issue is relatively simple to answer : new products get developed based on the likelihood of their success. With a lot of retail and institutional buyers pumping in money, there is always a demand for newer types of funds to invest in. For fund houses, it is an opportunity to have a specific charter which may not be possible to fulfil through their regular funds. For example, one of the ICICI value series funds only wanted to invest in Pharma and IT sectors as these were beaten down significantly over the last six months or so. Now this could be done in one of their existing funds too but for a fund manager to churn the portfolio by selling stocks that are doing well is not always an easy decision to take. Using fresh money in taking such calls is relatively simple. The trend started by end 2014 or so with ICICI and has now percolated to several others.

What are the pros and cons of such funds? Well, for one the mandates here have a lot more clarity compared to a vanilla large cap or mid cap fund. The fact that it is close ended, normally for 3 years, means that the fund manager has time at his disposal to take the calls he wants to take. On the flip side you will not have access to your money for 3 years and this is a problem unless you can definitely do without it for this time. A greater problem may be your inability to shift in case you are not happy with the performance. From my viewpoint, I do not see both these issues as a serious one. Firstly, you should be investing in equity for a much longer term than 3 years. Secondly, the Fund manager is way more qualified to deal with short term performance issues.

Let me now give some details of an investment that I made in one such fund. While the experience may not be repeated for all funds, it does offer certain insights:-

  • I purchased ICICI Prudential Value Fund series 2 on 6/12/2013. Invested amount was 2 lacs in the Dividend option.
  • The idea was to get some regular income as I planned to go for my consultancy practice sometime in 2014.
  • Though it was a 3 year fund, it has now been rolled over and will mature on 31/12/2018.
  • So far total dividends have amounted to 2 lacs
  • Current value of the fund is nearly 2.6 lacs

I think it can be said quite safely that this worked out quite well. In fact, I have invested in several follow up NFO from ICICI. Apart from ICICI I have also tried out Axis, Birla Sunlife, Sundaram and UTI for close ended funds. From a personal perspective it works well for me as I get tax free income and also growth from it.

You should be investing in these funds under the following situations:-

  • You have some income requirement every year. Instead of doing FD you can go for close ended funds with dividend option. Note that the dividend is not guaranteed.
  • You have a goal after 3-4 years. This is ideal for such situations. However, in such a case choose the Growth option.
  • You have come into some money and do not want to decide on allocation for 2-3 years as you may need the money then. Go for the growth option here too.
  • Make sure you understand the mandate and therefore the associated risk profile. A micro cap series from Sundaram will obviously be more risky as compared to the Value fund series of ICICI. However, the rewards will vary in a similar trend too.

If you are interested in these funds after reading this post, do consider the ICICI Prudential Bharat Consumption  Fund – Series 2 which closes for subscription on April 26th. It is in areas where there will be definite growth and the industries they are investing in will be likely to do well for the next 10-15 years and maybe even longer. The theme of investment is consumption oriented – all of these have great potential and are likely to do well in both medium and long term. The 3.5 year close ended NFO may just be the right vehicle for any medium term goal you have. For example, I feel of you want 5 lacs after 3 years, you can just invest 3 lacs in this and wait for 3 years. It is very likely that you will be able to realise an amount close to your goals.

People having surplus money and waiting to invest in some suitable avenue should take hold of this opportunity.