{"id":25,"date":"2020-09-28T17:12:37","date_gmt":"2020-09-28T17:12:37","guid":{"rendered":"https:\/\/equitable.in\/blog\/?p=25"},"modified":"2020-09-28T17:29:18","modified_gmt":"2020-09-28T17:29:18","slug":"do-you-collect-funds-the-way-stamp-collectors-collect-stamps","status":"publish","type":"post","link":"https:\/\/equitable.in\/blog\/do-you-collect-funds-the-way-stamp-collectors-collect-stamps\/","title":{"rendered":"Do you collect funds the way stamp collectors collect stamps?"},"content":{"rendered":"\n

What to do when the number of funds in your portfolio grows too large<\/em><\/p>\n\n\n\n

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Many investors collect funds the way stamp collectors collect stamps. Over a period of time, the number of funds in their portfolio grow very large. This makes the portfolio unwieldy and affects its returns. Let us look at why the number of funds in a portfolio proliferates, its negative consequences, and the best way to go about pruning your portfolio.<\/p>\n\n\n\n

Such proliferation of funds within a portfolio has negative consequences. Monitoring the performance of so many funds become difficult. Some of them inevitably underperform and this drags down the overall portfolio returns.<\/p>\n\n\n\n

Another problem that happens is duplication. If you have, say, too many large-cap funds in your portfolio, there will be a considerable amount of portfolio overlap. Many of the stocks that these funds hold will be the same. Thus adding more of the same. They will not provide greater diversification within the portfolio. In a market situation where, say, the large-cap category is underperforming, having too many funds from this category will drag down your portfolio.<\/p>\n\n\n\n

Once you realise the folly of having too many funds, you may want to prune your portfolio and make it more manageable. It is suggested that you follow a top-down approach to achieve this goal. First determine the time horizon you have for meeting your goal and your risk appetite. Based on this, decide on your asset allocation. Now suppose that you have a 10-year horizon for meeting your goal and are a moderately aggressive investor. You may decide on a 70:20:10 allocation to equities, debt and liquid funds.<\/p>\n\n\n\n

Next, you must decide on your category allocation. The portion you have decided to allocate to equities should then be divided in the ratio of 70:20:10 between large-cap funds. You may then decide to have two or three large-cap, mid-cap and small-cap funds. You may then decide to have two or three large-cap funds, one or two mid-cap funds, and one small-cap fund. Now select the most consistent funds from each of these categories that you already have within your portfolio, and get rid of the rest.<\/p>\n\n\n\n

A similar approach may be followed on the debt side. Here, you may decide to divide a longer-term portfolio between one duration and accrual fund. Again, select the funds from these categories that you already hold, sell the rest.<\/p>\n\n\n\n

More conservative investors may have a higher allocation to large-cap funds and less to mid-and small-cap funds that tend to be more volatile. Similarly, more conservative debt investors may have a higher allocation to accrual funds and less duration-oriented funds.<\/p>\n\n\n\n

Experts say that 8-12 funds are sufficient for most portfolios.<\/h3>\n\n\n\n

When getting rid of a fund, try to minimise the cost. Such costs can arise due to taxation and exit load. Waiting for a long time will carry its own costs in terms of portfolio underperformance.
Having created a well-diversified portfolio based on the asset allocation approach, avoid the urge to add funds. Review the performance of your funds after every six months or one year. If one of them is a consistent underperformer for four quarters compared to its benchmark and category average, you may remove it and replace it with another. Short-term underperformance should be overlooked. So long as your portfolio is on track to meet your financial goal, avoid unnecessary churn within your fund portfolio.<\/p>\n\n\n\n

Bond downgrades hit debt funds<\/h3>\n\n\n\n

When a rating agency downgrades a bond, the NAVs of bond funds that have invested in these bonds take a hit. With the securities and Exchange Board of India (Sebi) asking rating agencies to turn more proactive and downgrade a bond before it defaults on payments, the frequency of such episodes is likely to increase in the future. In such an environment, investors need to turn far more cautious in selecting bond funds.
Newspapers are full of reports of rising NPAs (non-performing assets) of banks. Many of the entities that have raised money from banks have also issued bonds in the markets which fund houses have invested in. If these entities are struggling to pay the interest or principal on their bank loans, it stands to reason that they are also going to struggle to pay the bond investor (in this case, the mutual fund).<\/p>\n\n\n\n

In such an environment, the fund managers of debts funds should not rely on the ratings provided by rating agencies, but should also do their own due diligence. They also need to avoid exposure to weaker or poorer quality bonds. However, a lot of funds are flowing into debt funds (just as in equity funds), and there is also a lot of pressure on fund managers to generate higher returns. This sometimes forces them to invest in poorer quality bonds.<\/p>\n\n\n\n

In such an environment, investors putting their money in debt funds also need to be cautious. They should not just select a fund simply on the fact that it has given high returns, but should also look on how the returns were generated. Often, higher returns are generated by taking higher risk-by investing in lower-grade debt paper. Investors need to decide how much risk they are comfortable with. They should not invest in a fund that has invested in a very low-grade paper. Rating agencies also sometimes give a rating to the overall portfolio of a debt fund. Investors may consult these ratings while choosing a fund.<\/p>\n\n\n\n

The level of risk that an investor is willing to take depends on his risk appetite. However, it is suggested that most retail investors should avoid funds that hold paper below AA+ level.

Another way you can avoid credit risk within the debt portfolio is by ensuring that the portfolio of the fund is well diversified. High exposure to a poor-quality bond increases a fund\u2019s risk. In particular, take a close look at the top 5-10 holdings of the fund. These bonds should be of high credit quality and should be backed by quality business groups (which will not want the loss of reputation that comes with a default).

Besides looking for diversification in individual fund portfolios,also ensure that your overall debt fund portfolio is well diversified. The bulk of your portfolio should be in funds that carry very little duration or credit risk. Only in10-20 per cent of the portfolio should you take some risk (conservative investors may avoid even that).

Also pay heed to the expense ratio of the debt fund. Remember that if the fund\u2019s expense ratio is low, the fund manager need not take too much risk to generate a reasonable return. A high-quality portfolio with a low expense ratio will generate similar returns as a lower-quality portfolio with a higher expense ratio, while taking on a lower level of risk.

Within debt funds, you have a type of funds called credit opportunity funds. They take a higher level of credit risk than plain-vanilla accrual funds. Don\u2019t invest in them just because they have given high returns in the past. Invest only if you have the necessary risk appetite. To reduce the higher risk of these funds, limit the exposure you have towards them in your overall debt portfolio.

Another way you can reduce the risk in this higher-risk category is by having a longer investment horizon. Bear in mind that many credit opportunity funds also have higher exit load. If you panic after a default and want to exit load, you may take a double-hit-owing to the mark-to-market impact and also due to the exit cost.<\/p>\n","protected":false},"excerpt":{"rendered":"

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