Wednesday, June 3, 2009

How to earn better returns from your MF portfolio

Pick up any mutual fund portfolio of an active investor and you will usually find it beset with typical problems. These can affect the overall performance. If we can understand, identify and rectify these common blunders, we can make much better returns out of our money.

A bloated Portfolio

Many people have the habit of collecting funds. Over time, therefore, you will find such portfolios having 40-50 funds. Diversification is good, but over-diversification is not.

Firstly, a large portfolio would mean that some funds in the portfolio will always be below-average, thus dragging down your total returns. Secondly, even with all the support of the computers and specialized websites, it is not possible to effectively manage a large portfolio. This again is going to impact the performance on the whole.

One should, therefore, have a limited but power-packed portfolio. The idea is to extract maximum punch with minimum cost and effort.

Chasing the Top Performers

There is too much focus on the performance and that too usually the recent one say over 3 months to 1 year. That’s why you always find this fascination among people for fund rankings.

Of course, performance matters! But making performance (and that too short-term) as the sole selection criteria can prove counter productive.

Historical evidence shows that no fund can always remain the top performer. It also shows that a fund, which has been consistently amongst the top quartile say over 3-5 years, will usually continue with its’ good performance. Similarly, a consistently poor performing fund usually finds it difficult to make it to the top.

Besides this the markets, as we all know, are highly sentiment-based. Therefore, more often than not, you will find some theme or the other being market fancy. It could be infrastructure, mid-caps or technology and so-on. At any given time you will find that most of the top performers belong to the same category.

So if you chase top performers you will end with similar schemes in your portfolio. In the process, the portfolio becomes concentrated, defeating the very idea of using MFs to diversify one’s investment.

Your focus should not only be the past performance but also reputation & management of the AMC, fund’s investing style & focus, asset size, etc., besides of course, other key factors such as your investment horizon, risk appetite and other funds in your portfolio.

Mismatched and Unbalanced

It is but natural that the money you need in the short term should be in debt, while only the long term money should be in equity. Liquidity apart, your asset allocation between debt and equity should be in line with your risk appetite.

Some people of course do not do so. Some others start in planned manner. But, as equity and debt follow different paths, over time the portfolio will become mismatched and unbalanced.

As such you may either be over-exposed to equity thus increasing risk; or under-exposed thus losing out on the benefits of equity.

Or a liquidity mismatch may happen between the investment and your need. For example equity markets may be down when you need money, thus forcing you to sell at a loss.

Thus your portfolio needs timely review and correction in tune with your risk appetite & liquidity needs.

Infested with NFOs

Thousands of pages have been devoted to pointing out the myth of NAV. Yet the logic that NAV has absolutely no bearing on the future returns, simply does not register with a common investor.

Hence one can see thousands of crores flow into NFOs especially in a bull market, while the existing funds get practically nothing. In fact, it’s the opposite. People switch out of existing schemes to invest in NFOs under the false impression that Rs.10 NAV fund is cheaper.

As such a typical portfolio would be infested with NFOs. Higher costs in NFOs vis-à-vis existing funds will eat into the returns. Also as the so-called low NAV is why you invested in the NFO, it is quite likely that the fund’s style and focus does not fit with your needs. This also is going to hamper your returns.

Too Much Churning

Call it impatience or a false sense of being proactive or the instant-culture - we simply cannot wait and watch our portfolio grow. We always feel that we need to do something regularly.

Therefore, as soon as a fund shows good appreciation, we are quick to book profits. Or if a fund does not move for some time, we are equally prompt to dump it. This, for one, is adding to the costs in terms of capital gains taxes, entry loads, exit loads, STT, etc. But more importantly, we may be getting out too soon and thus missing out on future performance.

For example, I know investors who want to exit from some funds whose focus is on smaller or mid-sized companies. Now these are the funds, which usually will take time to show returns. It’s quite logical. A Bharti or a Suzlon or an Infosys did not become big in one day. Similarly, who knows how many such future stars are there in these funds? If we wait for 3-5 years, many such budding companies will blossom into beautiful flowers and give us super-normal returns. The question is – are we willing to wait for it?

Building and maintaining a well-diversified and balanced portfolio is no rocket science. All it needs is common sense and discipline to act prudently, promptly and purposefully.
-- Sanjay Matai

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