The Mutual Fund Show: How To Build A Portfolio For Bull And Bear Markets
How investors can build an all-weather portfolio of mutual funds...
Investors should look at making a portfolio of funds that can survive the test of both a bull market and a bear market, according to A Balasubramanian of Aditya Birla Sun Life Asset Manage Co.
A core portfolio should be about 60-65% of an investor’s assets under management, Balasubramanian, managing director and chief executive officer at the asset manager, told Niraj Shah on BQ Prime’s weekly The Mutual Fund Show.
Investors should consider investing in a combination of three equity mutual fund schemes, which they term as “pro-investing”, he said.
Pro-investing will include the following:
Large-cap fund: Invests in frontline stocks.
Flexicap fund: Allows flexibility to fund manager to invest across categories.
Balanced advantage fund: Takes care of asset allocation between equity and debt.
Investors have a tendency to pick best-performing schemes depending on the investment horizon, Balasubramanian said.
According to him, pro-investing helps to tide over volatile market cycles, and aims to enhance returns in a bull market and manage risks in a bear market. It offers the stability of large-cap funds, the alpha from flexi-cap funds and debt exposure through balanced advantage funds.
Watch the full show here:
Edited excerpts from the interview:
Is it even possible to conceive a portfolio which can be an all-weather portfolio?
A Balasubramanian: …The bigger challenge for every investor is actually investing in the equity market or creating a portfolio that could help in creating longer-term wealth. Most of the time, the question that comes in the minds of people is how do I go about creating a core portfolio.
Core portfolio is something essential in everyone's portfolio to create longer-term wealth. You end up having a confusion in terms of the variety of mutual fund schemes out there. There are many categories there–which categories should form part of my core portfolio, should become a part of my permanent portfolio, and which part of the mutual fund multiple schemes can be considered over and above that, that’s always a question mark.
As per our own analysis, the research undertaken, the large component of the core portfolio is like any money manager constructs a portfolio.
As a money manager,... I will design a portfolio strategy into two parts: one is the core portfolio and the second is the satellite portfolio. Satellite portfolio is something which I will use for differentiating my portfolio return and core is something I likely buy for longer, buy and hold and keep it for long-term wealth creation.
Assuming that you draw a parallel of the same thing, same portfolio construction concept, but from an individual investor’s point of view or HNI point of view, they have to apply the same principle. Investment does not change from person to person…
We must look at pro investing as a principle, given the fact that we have been doing educational initiatives across different topics like SIP, STP, or investing in equity, investing in debt and within that category of equity investing…
Every investor who has money first has to get onboarded in Balanced Advantage Fund. An investor has not been trying out much of equity, at the same time he wants to have the flavour of equity, at the same time he is coming for the longer term. The money manager will take the call of going in and out, depending upon what the market outlook is, in terms of allocating equity or reducing equity and so on and so forth. That’s why first and foremost comes the Balanced Advantage Fund.
Then comes investing in bluechip, large cap, frontline companies that have established track record... That could potentially become the second large component of our portfolio allocation.
…Sometimes we do get confused between which market cap company I should make an investment in. Sometimes we believe that mid cap could potentially run and therefore I should have mid cap, or large cap would do very well, and so I should have large cap. That's something you are not going to find an answer as a common investor. That’s why leave the choice with money managers such as a flexi-cap fund. The money manager uses his own reset capability, macro understanding that he has. At the same time, he also sees where the big money can be made vis-a-vis one segment of the market or market cap, on basis which he allocates money…
Sometime he is skewed towards large caps, sometimes towards mid-caps or small caps to generate optimal return over a period of time. We need to look at each of the concepts from a risk category point of view.
…Balance Advantage Fund, then comes the large-cap funds, and third is flexicap. This, we believe, should form part of the core portfolio of investors, whether they make lump sum investment, or SIP investment, or STP investment by putting money in liquid funds or the debt funds…
Whichever way you actually make the investment choices, end of the day, for anyone to generate longer-term wealth and longer-term fulfilment of your dream, for which they have to make investment in equity…
Within equity as a category, these different types of schemes should form part of the core portfolio construction of the investors. That's why we came with a concept called pro investment.
Education at the broader level can’t be done, unless we address specific issues that investors have in their mind and help them take informed decisions by creating a deeper understanding of how the portfolio has to be constructed... Pro investing as a concept and educating the investor came with this background.
Do you reckon this will be a prudent strategy for investing, whether the trend of the market may be upwards or downwards going ahead? How would such a portfolio limit the downsides that come in during a bear market, because a large portion of this set of portfolio funds that we build is still equity-linked or equities per se?
A Balasubramanian: The way we have gone about choosing this entire category of schemes. As I mentioned, we have only chosen three categories. One is the Balanced Advantage Fund which moves equity… depending upon the market multiples, valuations… If you are not bullish on the equities, then there is lower exposure to equity. This takes care of potential risk arising on account of market volatility.
Whereas the large-cap oriented funds or funds that invest in frontline companies, that takes care of coming into the Sensex or Nifty and staying invested for long periods despite all the volatilities. That takes care of your second large component of allocation…
There are times when market favours only one segment or market cap, and one segment or market cap companies gets neglected. That's something taken care by flexi-cap. The risk associated with the market, whether it is through the fluctuations, whether it is the trend change seen happening, or whether it is the valuations, all such things are taken care of by these three components of the portfolio.
…The only question which remains unanswered is how much of the allocation of money of investors…
On a 1 to 10 scale, the risk of a Balanced Advantage Fund would come at 5 or 6 or 7… Then, you have large-cap oriented fund, it will come in at 7.5 or eight. Then the flexi-cap will come at 8.5 or 9 or 10.
It takes care of the potential risk value you may be facing on these allocations and the potential missing out fear that we may have by having the responsibility lying with the fund manager...
What percentage of the overall portfolio should be the core portfolio?
A Balasubramanian: Roughly about 65% portfolio… Any portfolio in the case of equity or maybe any personal investment, anywhere between 50-60%, one makes investment in equity and the rest comes to asset classes...
If you have to draw a parallel, within the core portfolio, within equity investing, 60-65% should be forming part of the core portfolio.
Look at the size of the industry. You have Rs 20 lakh crore size of the industry. You remove the ETF, which is more of index-oriented funds… I mean actively managed funds is roughly about Rs 13.5-14 lakh crore.
Within that, almost about 60% of the assets under management within the active category would come from these three categories.
The SPIVA indicators show that, for example, pure large-cap funds have not been able to outperform the index ETFs by a wide margin. There could be exceptions, but those will be exceptions to the rule. Would it pay to actually look at index ETFs or passive large-cap products as opposed to actively manage the frontline products? Would that be a strategy that could be pursued?
A Balasubramanian: One cannot rule out that… I have the belief that ETF should sit over and above the investment that we make in active managed funds. It is complementary and not a competition.
…The index is driven by a few stocks which have got large weightage in the index. Sometimes, the index is driven by a few sectors that have large dominance in the index...
Companies or sectors don't remain favourable at all point of time, depending upon the market situation in which you operate.
In such a scenario, what do you do? The rest of the market starts performing. Even the money managers generally will have a tendency to outperform the market.
Historically, I have seen that most of the large-cap managers outperform the market not by buying large-cap names alone or not by mapping the portfolio to the index alone. His own ability to pick stocks which could be a performer better than the large market, that's something in the last few years we know for sure that the money managers have gone through a tough time, given the fact that markets are driven by few stocks and few sectors. Therefore, money managers have their own constraints on one side.
At the same time, during the pandemic, everyone in the market went through a different kind of cycle. But that's something generally not seen as permanent. Generally, the performance comes back to normal. Therefore, from an investor's point of view, core can be fixed… But ETF should be in addition to the core portfolio because I consider index investing, ETF investing as complementary.
Though index investing is actually lazy investing, no doubt, but sometimes lazy investing can form some portion of the portfolio, but not necessarily it has to come at the cost of the active allocation management.
One advisor made an argument on the show that the flexi-cap fund is apparently safer currently than a large-cap fund, and most of the flexi-cap funds have about 70-80% exposure to large caps in the industry currently. Instead of buying a large-cap fund, one might as well buy a flexi-cap fund because it's lower in risk and there is a possibility of higher return because of some presence of mid caps and small caps. Would you tinker around or do you believe that because you are making an all-weather portfolio, which could last 5-15 years, having both would be a necessity?
A Balasubramanian: Over a period of time, what makes the difference in fund management is the discipline that you bring in portfolio construction.
If you take large cap-oriented funds, definitely the discipline being adopted by them, the 80% investment in large cap, 15% comes from mid caps or maybe rest of the market cap companies brings a certain amount of discipline. The large cap also has got discipline of investing in various sectors, in relation to the sectoral weight in the index…
From an investor’s point of view, you need to have funds as part of your portfolio, which are highly disciplined funds, which will not have any other glamour attached to it like it will move from here to there and so on and so forth.
At the same time, you also have the Balanced Advantage Fund, it comes with the discipline related to valuations and so on so forth. Flexi-cap funds come as a high-risk category. At the same time, higher the risk, higher the returns long-term…
From the investor's point of view, the reason why we said that the three portfolio is very important. Most of the time, the investors keep debating how should I go about investing in one fund, two funds and three funds and so on so forth. The more you discuss this, invariably you will end up actually not choosing any or you end up choosing something which will carry more risk.
That's why I call it as a core portfolio as a concept. The money manager will buy large-cap banks, they actually buy the leaders in this category. There are 3-4 leaders and the money manager will buy banking as a sector in his portfolio knowing very well all the three will perform more or less the same. They will have all the stocks as part of the portfolio, given the fact that they are leaders in the industry. Therefore, the large-cap funds bring in that as a category.
Flexi-cap funds will have a different kind of strategy.
From an investor’s point of view, cutting across different cycles, different disciplines which money managers will follow, different risks each of the funds will carry, all the three will be addressed with the creation of core portfolio….
Even Rs 10,000 can be split between these schemes to create a portfolio, create a different experience.
Also, keep in mind no one fund performs in a linear fashion across cycles. Every fund will go through different ups and downs.
The way we have gone about choosing these three funds is that the Balanced Advantage Fund will actually have the least volatility compared to the broad market, then comes the large-cap, then comes the flexi-cap.
So, you are able to cut across these schemes as part of the portfolio selection, cutting across different market cycles, different fluctuations. Therefore, we believe that it should form part of the core rather than one or two.
Has there been any kind of back tests done for a portfolio like this? What kind of returns can it generate vis-a-vis the benchmarks and what kind of alpha?
A Balasubramanian: See, we are not doing any kind of back testing per se. Back testing is done only on ways of how money has to be allocated into various categories…
Given the fact that you have to weather market volatility, we have feedback from various people saying you are all saying equity is bullish, how do you go about investing in equity? This is a common question. All of us are bullish on fixed income schemes.
…We thought that we will help actually choose the funds of investors rather than selling the funds.
…What is most important actually is that investors are making for the longer term, how do the investments have to be allocated into various categories within the equity, and within the equity how I think about creating a core portfolio.
Return is a function of the market and if I have a longer-term outlook, if you have to take as 10-year, 15-year cycles, the experience would be either in line with the market or better than the market, given the fact that you will have a mix of these portfolios, which takes into account the market volatility and so on so forth.