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.

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 real life case study on retirement corpus deployment

Of late, I have been getting several requests from people about how to structure their retirement corpus to get a certain amount of income every month for lifetime. I was however, quite surprised to get a request last week – the person said that he had 3 crores and was willing to deploy it as per my suggestions and wanted to check how much he could spend per year, if he had a lifetime of another 30 years.

So let us see this from a very basic retirement maths perspective first:-

  • We will assume that the corpus is deployed so that the real rate of return is Zero. This essentially means that the returns from the portfolio will match inflation.
  • In this scenario his overall costs over 30 years will be 30X ( assuming he spends @X each year ) and the limiting condition is 30X = 3 crores. This means X=10 lacs
  • Going by this he can definitely spend an inflation adjusted amount of 10 lacs today.
  • Note that he will not have any issues with this strategy as even very conservative investments are likely to match inflation. He can put money in PPF, Debt funds, VVY, SCSS etc and still be able to achieve this.

Let us extend the logic a little further and see if we can do better in some way. We will try to structure the portfolio in a manner suggested below:-

  • Try to earn money in the first decade through debt investment returns. We will aim to earn 12 lacs in the first year to take care of the inflation within the decade. This is how it can be done:
    • 60 lacs in VVY and SCSS (for the couple) will yield 4.8 lacs a year.
    • 60 lacs in Debt funds will yield 4.8 lacs a year. This can be FMP type of funds where you use the capital gains for your expenses.
    • 20 lacs in IndiGrid InvIT which is likely to give 2.4 lacs a year.
    • 10 lacs in a liquid fund to cater for any financial emergency situation.
  • Put 1 crore in an MF portfolio over a period of time. This can be through STP of 1 lac per month for 100 months.
  • Put 50 lacs in stocks over a period of time. This should be based on markets and in the interim period the money can be kept in a Liquid fund.
  • At the end of the first decade, continue with the Debt plan as before. You will now be spending about 25 lacs per year and half of it is generated from Debt portfolio.
  • The MF will grow to about 1.6 crores by this time and stocks to 80 lacs. Set up a SWP from your MF to get 13 lacs every year @ 1 lac plus every month.
  • In the third and final decade, your MF portfolio and Stock portfolio will be enough to take care of your expenses @50 lacs a year.

Finally, what if you want to spend more now and taper off your expenses as time goes by? Many may want to travel around the world in their first decade and reduce it over time. In this case let us assume you need an average expenses of 15 lacs  in decade 1, 20 lacs in decade 2 and 30 lacs in decade 3. How do you cater to these?

  • Put 1 crore in Liquid funds and spend from it for the first 10 years. The amount earned through interest will enable you to do this.
  • Put 50 lacs in Debt funds, 1 crore in MF and 50 lacs in stocks.
  • After 10 years the Debt funds will grow to about 1 crore, MF to about 1.6 crores and Stocks to about 80 lacs. I have assumed staggered investments and conservative returns to make this a very safe plan.
  • In decade 2 spend from the Debt portfolio and do SWP from MF portfolio.
  • In decade 3 use MF and stock portfolio.

So to answer the question of the person, he can even spend 15 lacs per year with a 3 crore corpus as long as it is structured properly. In terms of withdrawal rate this is a 5% but it should work quite well.

I hope this has proved to be useful to most of you and you can structure your portfolios in a similar manner to maximise your spending power.

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.

Looking at fixed income? Consider this investment

In my blog one of the most common queries I get from retired investors and ones planning to be in the FI state , is where one should invest for fixed income. This is expected in the current scenario as most of the Debt investments suffer from some lacuna or the other. Fixed deposit returns are low with inefficient tax treatment, PPF is a great long term product but not for regular income before 15 years, Debt funds are not giving great returns and you need to hold on for 3 years to get indexation benefits.

So, if you have a reasonable sum of money and are looking to put it somewhere for regular income, what are your options? A year back one could have looked at Arbitrage funds or Balanced funds but with the LTCG taxation on equity this does not seem a good idea. Tax free Bonds are not being issued right now and when they are the interest rates will probably be only in the range of 7.5 % to 8 %. In the present scenario one product which can be quite useful to investors is InvIT that is Infrastructure Investment Trusts.

What are InvIT’s? They are instruments for infrastructure developers to raise capital. For investors, InvITs provide (1) an opportunity to invest in a de-risked portfolio of operating infrastructure assets for a superior risk-adjusted return, (2) potential of growth via acquisitions. In simple words these funds take over the significant loans for large Power, Road and other infra projects. The return to the investors are in the form of interest payments, dividends declared, buy back of units and capital appreciation.

Are these Equity or Debt investments? Well, a bit of both really. The revenues are linked to the performance of companies that these trusts invest in so there is an equity nature. At the same time InvIT’s receive annuity from the companies they invest in, which is more like fixed income. As of now there are only two InvIT’s that were floated in the markets in 2017. IRB was for the Road companies and IndiGrid was for the Power companies. The ticket size for investment was 10 lacs for both of these and they were over subscribed. IRB was priced at 102 Rs and IndiGrid at 100 Rs per unit.

If we look at the performance of these companies in terms of their share prices then they are a disappointment. IRB is languishing at 86 Rs and IndiGrid is at 96 Rs. However, the more important parameter is the DPU or Distribution per unit which is something similar to a quarterly interest payment by these trusts. Both the trusts have paid this in a regular manner and in the last quarter the amounts were 3 Rs per unit for them.

I am having 10206 units of IndiGrid and have had overall DPU of 9.56 Rs in the 10 month period of operation over the last FY. The guidance for current FY is 12 Rs. Of course since most of this is interest payment, it will be taxable. In addition these can also offer some dividends which will be tax free in the hands of the investors.

Should you invest in these? Well, if you are a retired person in lower tax brackets then these do seem rather attractive at 12 % returns. Even in the 10 % tax bracket this makes a lot of sense. I think it will be ideal to buy a combination of IRB and IndiGrid. Remember the first is riskier as it depends on toll revenues. If you want to play safe just go for IndiGrid. The ticket size is 5 lac Rs and if you invest around 20 lacs you will be getting an average interest of 20000 per month. It can take care of a fair part of your household expenses. Do remember though that these are unlikely to appreciate much in share value and will not be very liquid so selling them can prove to be a challenge.

On the balance though these are doing rather nicely from the viewpoint of fixed income. I wish I had invested 2-3 times of what I actually did in the IPO and I have definite plans to put in my next 5-10 lacs there when some of my Debt investments mature.

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.