How to realign your MF portfolio

In several of my earlier blog posts, I have covered practically all aspects of MF investments and you should be in good shape if you are starting off to create a MF portfolio from scratch. However, as some readers reminded me, most of us are already having an MF portfolio and some of us are having SIP investments in several funds. Different portfolios for different goals can also lead to people holding more funds than is either necessary or desirable.

The good thing is you can realign your portfolio and get into a logical allocation quite easily. As I have covered the basic logic of my suggested portfolio structure and SIP / one time investments I will not repeat them in this post. You can read these posts here and here. In this post I will outline a simple method by which you can realign your portfolio.

Step 1 : Be clear about your intended portfolio structure:

  • For the long term you need just 4 funds – a large cap fund, a mid cap fund, a multi cap fund and a small cap fund. If you want to hedge your bets you can add an International fund, mainly US based.
  • You do not need to have any Balanced funds, Sector funds or Thematic funds.
  • Always go for Direct funds as the lower cost will enhance your returns significantly over the long run.
  • Remember you need only 1 portfolio for all your goals and not a separate one for each goal.

Step 2: Map your current portfolio to the above portfolio structure:

  • Check if the funds you hold are aligned to the above portfolio. If not then discard them logically from your portfolio.
  • For the aligned funds, check if they are suitable for your portfolio. Read about how to select funds here. If any of the funds are not suitable then discard these.
  • We will decide what to do with the discarded funds later on.

Step 3: Get to your new portfolio structure:

  • Take whatever you have got from step 2 and add other funds based on the portfolio structure and the selection method.
  • Now you have s set of 4-5 funds in your portfolio. In all of these your investment value is either zero or equal to the earlier investment, in case you are retaining any of your earlier funds.

Step 4: Decide on your investment amount per month:

  • To begin with use a SIP calculator to check what should be your monthly investment. You can take any rate of return between 10 and 15 % based on your comfort level.
  • You can start by putting equal amounts in all 4-5 funds. However, if you prefer a fund type over another then you can tweak with the monthly SIP amounts. It does not matter a great deal, as long as you have got the portfolio correct.
  • Increase the SIP amount every year based on the availability of extra money to invest.

Step 5: Redeem the discarded funds at the right time and invest into your new portfolio:

  • Redeem your discarded funds at a time when it seems right. There is no exact formula but you can observe the trends and take a call. For example, if the Nifty reaches a level between 10800 and 11000 now it will be a good time to redeem the funds that you do not want to be in any more.
  • There is no rush in this, your investments are growing even if you have discarded the funds logically from your portfolio. Once you have redeemed the funds be in cash or keep the money in a liquid fund, till it is time to buy.
  • Invest the above money through one time purchases of the funds in your new portfolio at an appropriate time.

As you can see from here realignment of the portfolio is a fairly simple exercise, once you are clear about the mechanism. If you feel that you need to do it, the right time to start is NOW. In case you are not invested in the right funds then any further investment in them is completely senseless.

In case you have any questions on realigning your portfolio, comment on this post and I will be happy to clarify.

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Equity MF dividends – the whole story

After my last few posts I am getting a lot of enquiries from people as to what they should do about their schemes with dividend options now. Many are unclear about the tax and how will it be treated in their hands. In this post I wanted to demystify the dividends from equity MF and suggest ways about how you can deal with them.

To begin with let us understand how a Dividend option of an MF scheme is different from a stock. Any company, whose stock you hold, will pay you dividends from the profits that it makes in a quarter or year. Based on the amount of dividend paid the stock price will normally fall initially but may well rise later. In the case of a Dividend paying MF scheme, the dividends are being paid out from the assets held by the scheme. As some of these assets are liquidated the NAV of the fund will necessarily fall after a dividend is declared. Yes, it may rise again if the stocks in the MF scheme portfolio do well but it is fundamentally different from the stocks.

Let us now examine the taxation aspect of dividends before and after the budget. When a company declared dividends it was out of the profits where taxes have already been paid by the company. Therefore the dividend that investors received was tax free. In the case of equity MF schemes too they did not pay any holding tax and whatever dividend the investor got was again tax free in their hands. After the budget the situation remains the same for stocks but has definitely changed for MF schemes. These will now have to hold a tax of 10 % before distributing the dividends to the investors. This is the Dividend Distribution Tax ( DDT ) newly introduced in this budget. Remember that Debt funds always had a DDT of more than 28 % earlier and continue to do so.

How does this change things for you now? Well, for one you will have lower dividends for your equity MF schemes due to the DDT. Typically this will be 10 % lower. It will continue to be tax free in your hands. For example, I had invested 2 lacs in the dividend option of a  Value Fund series NFO from ICICI. Every year I would get 15000 Rs dividend from this investment. All things remaining equal, the value of this dividend after the new DDT rule will be 13500. If an investor is depending on these dividends for passive income then he will need to get this shortfall from somewhere else.

In general Dividend option is not a good idea for equity MF now – note that companies pay tax on their earnings and this is reflected in the stock price and also the level of dividend they pay to their investors. Equity MF are investing in these companies and are again paying DDT. Finally when you redeem these investments you will again be charged LTCG tax at 10 %. It will be much better to just deal with the Growth option where you just pay LTCG tax when you redeem your units.

Let us now look at some classes of investors who are currently invested in these MF schemes and what they should do about it:-

  • If you are in the active income earning stage of your life, there is no logic in having Dividend options for your MF schemes. Change all of them to growth. Even if you need the money you will be better off just redeeming some units as and when you need to do so.
  • If you had chosen this option in order to do some explicit profit booking by the Fund houses then your concept was wrong. Fund Managers will churn their portfolios as and when required and these benefits will reflect in the NAV of your scheme. There is really no need to invest in the Dividend option for it. You should also change it to Growth option.
  • People in the retired or FI state may have invested in these schemes as a means of getting regular income. Some Balanced funds have schemes where they distribute a monthly dividend. Note that all of these are subject to DDT now – so either you will get less dividend in your hands or the fund NAV will fall more if the same dividend is to be maintained.

Except in the last case, where some people may want a hassle free receipt of dividend as compared to redeeming units on their own, there is really no point in Dividend options of MF schemes now. In fact, with online redeeming being possible, anyone can sell units of MF schemes rather easily and I will definitely recommend that.

Short conclusion to the story – change all your MF schemes to Growth option right now!!

How should you invest in Mutual funds now?

Whichever way you want to look at it, the Finance minister has definitely sent all MF investors in a tizzy with his LTCG taxation on equity. This was always likely to happen and many investors, used to a diet of high growth with no taxes to account for, are shocked and wondering what they should do with their existing investments and new ones. I will give you a very clear recipe in this post that you can follow effectively.

To begin with, the popularity of MF investment through SIP were due to two main factors. The first was the marketing skills of the Fund houses and the awareness on inflation created by the myriad financial blogs and Facebook groups. Investors realised that traditional investments such as Fixed deposits, PPF, LIC schemes, Bonds etc would not keep pace with inflation and they had to look at equity to a certain extent for meeting their important life goals. For these set of people, investing in MF seemed like a less risky idea as compared to direct equity. The successful model of sales and distribution put in place by Fund houses have ensured that they have mopped up amounts nearing 1 lac crore annually.

However, there was another reason which many are not cognisant about. When the Finance minister change the LTCG indexation benefits from 1 year to 3 years in his first budget, he actively pushed people away from schemes like Fixed Maturity Plans. With declining interest rates, longer holding period and reduced inflation unfavourably affecting the indexation benefits, suddenly Debt funds were really not a good option for people wanting to park their money in short term. The Fund houses responded by coming up with schemes like Arbitrage funds and Equity Savings funds where the safety was greater than pure equity funds, returns were better than Debt funds and the holding period needed to be one year only for getting tax exempt returns. Many Fund houses even offered monthly dividend on Balanced MF schemes which were particularly suited to retired people, in search of a regular monthly income.

Thanks to the FM all this is a matter of the past now. Given the current situation, how should you deal with your MF investments? I have put together some simple guidelines for different types of investors, that will give you a clear road map of what you should do:-

  • If you are an investor whose goals are still some time off:-
    • Keep investing in your SIP as before but add 10 % to the amount for taking care of the eventual taxation.
    • Make sure you have only Growth option schemes in your portfolio as it makes little sense to get dividends now, unless you really need it.
    • If you have set up STP for your monthly flows into SIP, evaluate if this makes sense. You will be taxed for selling the funds now.
    • As churning is detrimental to your returns now, make sure you select the right MF schemes and stick to them for the long term. Yes, you still need to review etc but change the scheme only when really needed.
    • The longer you hold your investments the better it will be for you. Redeem only when you actually need the money, not otherwise.
  • If you are an investor with major goals coming up:-
    • Check out if you can meet your goals through existing Debt investments and keep your MF investments running for a longer term.
    • If this does not work, redeem from your MF schemes only the amount you need right now for the goal. For example if your child’s college fees are 20 lacs in 4 years and 5 lacs per year, then redeem only to the extent of 5 lacs.
    • If the markets manage to go up beyond the Jan 31st levels within March ( this is unlikely, but you never know ), redeem your MF units to the extent of the money you need for your goals in the next Financial year.
    • As before, avoid Dividend options and if you have any MF schemes with these then change it to Growth.
  • If you are retired or in need of regular passive income in your Financially independent state:-
    • If you had set up Arbitrage funds, Equity Savings funds or invested in Dividend option of some close ended equity NFO’s check your taxation impact and decide if it is making sense.
    • If you are a senior citizen take advantage of the 50000 Rs interest exemption and the LIC scheme with 8 % interest.
    • Rearrange your MF investments so that you only get the Dividend amounts that you need regularly. For any sudden or unplanned expenditure, you can always redeem your MF units within a day.
    • Do not churn your MF investments needlessly, you will end up paying more taxes by doing this.
    • Finally, even in the new tax regime, do not give up on equity MF. It is important for you to remain invested as a hedge to inflation.

As you can see from above, there is a need to take stock and possible reorganise your MF portfolio. However equity as an asset class and Mutual funds as an investment vehicle are still the best in the business and you should continue to bet on them.

If you have any specific queries I will be happy to answer them through my Blog or through the two Facebook groups that I run.


MF investments and LTCG tax – the real impact

With a lot of heat and dust about the LTCG taxation on equities one aspect of it, namely, the real impact of the tax on an investor’s long term return have largely got very little attention. I was made aware of it through an article by Dhirendra Kumar of Value Research Online and largely agree with what he has said. As many of the investors may have missed out on this, let me try and explain it in this post.

Now, we all know that it is possible for equity to grow at a rate of 12-15 % in a long term period of 10 years and more. Of course, the growth in equity is non-linear, meaning you may well grow 30 % in a year like 2017 and even have negative growth as in 2008 and 2011 etc. If we look deeper into the growth of our MF investments we will see there are clearly 2 parts to it – first is the inflation prevalent in the economy and the second is the real return you get on your investment. For example, if your MF investments have grown by 15 % and inflation during this period was 8 % then your real return is 7 %. In general, your real return can exceed 10 % in a good year for the markets and will be in the range of 4-8 % in other years. Again, if the markets turn negative or are mostly sideways in a year then your real returns may well be negative.

With this backdrop, we will take an example to understand the impact of the recently introduced LTCG tax on equities on your MF returns:

  • An investor starts investing through SIP in one of the popular MF schemes from April 1st 2018. Let us say the amount is 20000 and he wants to do it for 15 years.
  • At 12 % annual returns he will get about 1 crore, which he plans to use for his daughter’s higher education.
  • His overall LTCG will be to the tune of 64 lacs and the tax thereon will be 6.4 lacs.
  • Now if we assume that the inflation component is 6 % and the real returns are also 6 % then the real returns are to the tune of 32 lacs.
  • In effect you are paying 6.4 lacs tax on a 32 lac real gain – this comes to 20 % and not 10 % as most of us are given to understand.
  • This situation could have been corrected if indexation was allowed but that has not been done in the case of LTCG on equities.
  • The 1 lac exemption etc has very little meaning for people looking at a large goal as it will be an insignificant part as compared to the goal amount.
  • In simple terms you are being taxed on inflation too, which is grossly unfair !!

In terms of the goal itself, you will need to increase your monthly SIP amount by 1281 Rs so that you are having the required goal amount after taxation.

So what can you do from your end to see that you minimise the taxes at least? Well, for one, you can spread the redeeming over the years of college so that the impact will be shared over 4 years or so. This will not affect the total tax outgo but you will feel better that your tax payment at one time does not appear so horrendous.

I hope the intelligent readers would have understood the real dangers here. Even if your real return is much lower, say 10 % you still pay a lot of tax. For the above example at 10 % returns your LTCG is 47 lacs and you pay tax of 4.7 lacs. As a percentage of real return you are now talking of well over 30 %. If your real returns are even lower if the market tanks in that year, then the tax paid as a percentage will be even higher.

The conclusion is a simple one – by not allowing for indexation the FM has really dealt a body blow to long term investors who have been investing seriously over the last several years and have played a stellar role in the success of our stock markets.

What strategies can you adopt for your investments? I will take this up in another post.

ICICI Value Fund Series 20 NFO is on – 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 1.75 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 Value Fund – Series 20 which is open for subscription now and closes on 31st January. 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 5-10 years and maybe even longer. The fund is termed as Rising Bharat Opportunities Fund. The 3 themes will be Build Bharat, Finance Bharat and Rural Bharat – all of these have great potential and are likely to do well in both medium and long term. The 3 year plus 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. A disclaimer I need to make is that I am invested significantly in this series of NFO from ICICI  MF and have plans to invest in this too.

My current MF portfolio – Close ended Equity Funds

One of the interesting and fortuitous occurrence in my investment journey is how I started to invest in close ended equity funds. Till 2014 beginning, I had always avoided these funds as I wanted to have the flexibility of getting out of a fund if I wanted to. A combination of my looking for some regular income as well as a need to invest some amount one time, made me look at the ICICI Value Fund Series 2.

You would have been told by many people that close ended equity NFO are a bad idea as they operate for only 3-5 years normally and that is less time for equity investments. Is there data to support this? Yes, it is true that if you pick a 3 year period on a rolling basis, there will be enough instances of low returns or negative returns. At the same time many such periods have also given spectacular returns. So if you are in the right period and with the right fund then it makes sense to go by this route. The ICICI Value fund series also has a mandate for distributing dividends to share profits with investors. This suits me admirably as I was looking at tax free passive income from 2015 onward.

Now to cut a long story short, I have since invested in several of the series so far. The funds have mostly done well and quite a few have given fairly regular dividends. It is important to note that each fund from this series as well as the other fund houses with such schemes are focused on doing things a little differently as compared to open ended funds from the same fund houses. Some of the differences are as follows:-

  • Being close ended there are no redemption pressures and therefore the fund manager can take slightly longer calls.
  • As it is time bound the churning mechanisms are different from open ended funds.
  • Profit booking is implicit as most of them have a mandate to declare dividends.

Let us now look at my portfolio in these funds:-

  • I have started with ICICI Value Fund Series 2 and gone through to Series 19 which was running this month. Have invested in about 14 out of the 18 series.
  • The lowest XIRR has been 15 % and the highest 35 %. Most of the schemes have given an XIRR of over 25 %.
  • There has been good dividends every year from these schemes from 2015 to 2017.
  • Some of the other close ended schemes I have invested in are:
    • BSL Resurgent India fund Series 1 through Series 5
    • Axis Equity Advantage Fund Series 2
    • Sundaram Select Micro cap series 14, 15
    • Similar funds from UTI and SBI fund houses
    • HDFC Housing opportunities fund
  • My total contribution from these in my current portfolio is about 30 %.

These investments are clearly for the more experienced investors who can look at the mandate of these NFO’s and decide whether they want such coverage in their portfolio. There is an element of risk in a market downturn over 3-4 years but, in that scenario, you will do doing badly in all your MF investments through SIP too.

How do you invest in these funds? Well, be on the lookout for NFO, study the mandate carefully and put in only any surplus money you may have. Remember you should not replace your regular SIP with these. However, these can form a great medium term investment for any goals you may have in the next 3-5 years.

So if you are planning an expensive car or a family vacation outside India in 3-5 year time frame these funds may be the best ones for you.

My current MF portfolio – Open ended Equity funds

Readers who are familiar with my blog for some time will know that I have 3 portfolios of Stocks, MF and Debt. It is my strong belief that the 3 portfolio strategy is ideal for any situation and provides for adequate growth while containing the risks to a good degree. Out of these I normally write mostly on my stock portfolio as that is the one which needs more knowledge and is also what most readers want to know more about.

However, in the last week I have received several queries as to how I went about building my MF portfolio over time, what schemes do I currently have, do I still do SIP and so on. As my MF portfolio is quite diverse, let me try and answer this in 3 parts. The first is covering the Open ended Equity funds, the second the Close ended Equity funds and the last will deal with Debt and Hybrid funds.

In chronological order, this is how my Equity MF investment journey has been :-

  • My first introduction to MF was in 2001 through a Financial Adviser. We invested in Franklin Bluechip and ICICI Technology fund for about 1 lac overall. Both of these are still in my portfolio and have done reasonably well, though I have not added much to these over the years.
  • My next foray into MF was only in 2005 as in the interim period our focus was on building the stock portfolio and paying off the home loan. In the 2005 – 2006 period there were a spate of NFO from fund houses almost every month. I bought regularly in this period for a total of about 4 lacs – most of these have been sold off now, mainly in 2007 when the markets ran up really high.
  • Introduction to MF investing through SIP started in 2008 when the markets were down and I needed an alternative to buying stocks. We were doing SIP regularly into a portfolio covering 4 funds in different categories. Over the years, some of the funds changed but the investment was regular till October 2015.
  • After 7 years of my SIP journey, I realised it was not really the best way to invest for an investor like me, who had good knowledge of the markets. I started to target buying at opportune times and also looking at MF schemes with long term themes.
  • After I gave up my regular corporate career, I have invested heavily in Close ended Equity NFO, in order to take short term benefits from market as well as to have an income source from dividends.
  • Right now I do not invest in Equity MF schemes unless they are of a specific theme. These investments are mainly into NFO buying.

Let me now give a snapshot of my portfolio. As before, I will try to focus on the schemes where the current portfolio value is more than 1 lac. There are a few other funds which I have in my portfolio but they are not significant in value. I will not get into the mode of acquiring the funds, SIP or one time buying as that again is not very relevant.

So here are the categories and funds from the regular open ended schemes:-

  • Large cap and Diversified equity funds in my portfolio are:
    • HDFC Top 200 
    • ABSL Frontline Equity
    • DSP BR Equity
    • ICICI Dynamic Plan
    • ICICI Focused Bluechip Equity
    • ICICI Value Discovery Fund
    • ICICI Exports and Other Services
    • UTI Dividend Yield
    • UTI Nifty Next 50 ETF
    • Franklin India Bluechip
    • CPSE ETF
    • Reliance Regular Savings 
    • UTI Bluechip Flexi Cap
    • HDFC Premier multi cap
    • BNP Paribas Long Term Equity 
  • Mid and small cap funds in my portfolio are:
    • Franklin India Smaller Companies
    • Sundaram SMILE
    • Sundaram Select Mid Cap
    • IDFC Premier Equity
    • DSP BR Micro Cap
    • HDFC Mid Cap Opportunities
  • Some other open ended funds I have with required value are:
    • L & T Tax Advantage
    • ICICI Prudential Technology
    • Franklin India Life Stage FOF
    • ICICI Prudential US Bluechip equity
    • Franklin India Dynamic PE Ratio FOF

Some numbers then – the above funds constitute about 62 % of my Equity MF portfolio. The rest are made of Close ended funds and smaller investments. 

I will address the Close ended funds in my next post.