The Art of Building a Mutual Fund Portfolio

While investing for a financial plan or otherwise, for investors, a mutual fund (MF) portfolio helps provide an excellent means of diversification, asset allocation, and building a good foundation. Mutual funds are a simple and convenient way to build a professionally managed, cash-rich portfolio that is actively adjusted to the market scenario. But the broad spectrum of MF is huge and huge. However, one needs to understand a little about the different categories and how it fits the plan; to ensure that a strong portfolio is built to benefit the interests of investors.

Investing otherwise comes down to the requirements and risk appetite of the investor. The risk cannot be avoided but could be mitigated by appropriate methods of asset allocation and diversification. The timeframes of the goals or the requirements of the investor therefore play an important role in mitigating the risk to some extent. We will dwell on this part in more detail. MF offers a wide range of solutions that allow investors to explore and gain exposure to equities, debt, commodities (gold/silver, etc.) and even some alternative investment options like REITs (Real Estate Investment Trust), InvIT (Infrastructure Investment Trust), etc.

Of course, the first thing an investor should do is draw up a timeline for investments. This helps in finding appropriate allocations to different asset classes. Keep in mind that short-term needs should always be directed to debt exposures. Within Debt, the sub-category allocations would be discussed in a moment. Thus, for a need of less than three years, exposure to equities may be limited or even nil. The equity allocation could be increased as maturities extend into the medium to long term over 10-15 years and beyond.

The choice of funds within equities could again be considered based on time frames, although an investor’s risk profile provides some insight.

Nevertheless, investors should remember that taking on higher risk is not always directly proportional to higher return. As for debt allocations, one might be comfortable allocating overnight or liquid funds if the time frame is 1 month or less. The choice improves as the horizon expands to around three months through ultra-short to low duration funds. Floating rate funds could serve as an antidote in a rising interest rate scenario, but the investor should be prepared to prepare for short-term volatility and would therefore suggest it within 3-6 months. Investors looking for two years and more might consider short-term funds or even bank PSU funds where the latter have a relatively lower risk profile. These fund categories are subject to interest rate or inflation risk.

Serious debt investors should consider investments with a horizon of three years or more as this offers better tax arbitrage. Mid-term and corporate bond funds fall into this category, with credit risk being one of the main criteria and suitable for a moderate risk appetite. For those with a higher risk profile, could explore gilts and credit risk funds which have higher volatility in interest rate and credit risk respectively. Investors with 5 years and over could expose part of their investments to these funds.

From a debt perspective, a portfolio with moderate liquidity and a 3-year horizon might consider an allocation of one-fifth to liquid funds, about the same part to the ultra-short term, while the rest might be split between short-term and corporate bond funds. A moderate 3-5 year portfolio might consist of a tenth of ultra-short and floating rate funds each, about a third of short-term and bond funds, another third of medium duration funds while the rest could be allocated to credit risk funds.

Hybrid funds are another category that could well be placed in most portfolios that offer the best of both worlds, i.e. stocks and debt. Some of these funds also have a small exposure to gold as an allocation hedge and even derivatives. These funds could also be used as a risk moderation tactic in the overall portfolio. An annual review of the FCP’s portfolio for rebalancing purposes could help keep it in line with market dynamics.

(The author is co-founder of ‘Wealocity’, a wealth management company and can be contacted at [email protected])