The Mutual Fund Show: How To Ensure Your Portfolio Performs To Its Full Potential

Investors must consider factors like asset allocation, investment horizon and goal while building a portfolio, says Amit Trivedi.
The gauges of a pumping unit. (Photographer: Aaron M. Sprecher/Bloomberg)
The gauges of a pumping unit. (Photographer: Aaron M. Sprecher/Bloomberg)

Mutual fund investors have had a rough ride in the last two years on volatile markets.

Investors are staring at negative returns on the back of a slowing economy, weak corporate earnings growth and geopolitical tensions. While the surprise corporate tax cut is expected to aid earnings and eventually private investments, there are still concerns about its impact on fiscal deficit in the short term.

The rout in the broader markets has been more severe with the mid-cap mutual fund category falling nearly 10 percent so far this year. While flows into equity schemes through systematic investment plans have remained consistent, market volatility has prompted most first-time and veteran investors to examine their investment strategies.

An investor must consider several factors like asset allocation, investment horizon and goals while building a portfolio, according to Amit Trivedi, author and financial adviser.

“People tend to mistake the meaning of aggressive as high returns,” he said in this week’s episode of The Mutual Fund Show. “But an aggressive portfolio is about high risks as well and not just high returns and whether or not the person is comfortable with that high risk.”

Watch the full show here:

In Charts: Surprise Corporate Tax Rate Cut Makes Investors $96-Billion Richer

Here are the edited excerpts from the interview:

What should my ideal mutual fund portfolio be? I thought the obvious way to start off with anybody, would be to try and figure out whether the portfolio is too aggressive or too passive. How would you respond to that?

Gaurav: So, this one line which I’ve learnt from Amit is, that, nobody in the world ever invests in mutual funds. You invest through mutual funds. So, through mutual funds, it gets into different asset classes. So, it could be equity, it could be debt, it could be combination, gold. India, we don’t have real estate funds though SEBI permits. So, what needs to be seen is the underlying asset class. If somebody is saving for a financial goal or an event which is likely to happen after seven to nine years, whether it is an SIP or a lump sum, it should be in an equity as an asset class, it will be equity fund whether it is active or passive; that’s secondary. If it is something which is going to happen in the next two to three years, it should be debt as an asset class and debt funds and there are various options and for interim, there is a combination.

Now, based on that, the allocation should happen. Now, if you’ve deviated, and if for a three-year goal you’re in equity, you are too aggressive. Because that should not have been the case in the beginning and if you are feeling the pinch now, it is because you went too aggressive that you shouldn’t have done. Similarly, if you’re going to retire after 15-20 years and have put it in a debt fund, then I am too passive. That shouldn’t have been done in the first place. So, the moment there is a mismatch between what I am saving and where my funds are, it will be aggressive or passive. That’s the mistake that should not have happened in the first place and now rectified. So, don’t go by the momentum because while the outside situation would be volatile, the situation which is not so volatile, it is more dynamic. I am just putting it in perspective for half a minute that, for example, if my daughter is likely to go for a higher education or her marriage is coming up in three months’ time, I am not going to going to tell her that, ‘beta, Sensex is down, don’t get married.’ My situations don’t change internally based on external conditions. So, why is my portfolio based on external conditions?

Wouldn’t age also be a factor whether your portfolio is either aggressive or passive?

Amit: So, age according to me is not that important, it is the time to the goal. So, I come across people and especially, one particular family that I met, a large business family—the father, 79 years old, was 100 percent equity, and his son at 40 years age was 100 percent debt. Both were right in their own way. But coming back to your original question of aggressive or passive, and I keep hearing this aggressive versus conservative as the words, it is important to focus on these words. When you hear the word aggressive, it’s better to check what the other person means by aggressive. A lot of times, the meaning of aggressive is, ‘I want high returns, that’s why I want an aggressive portfolio.’ But an aggressive portfolio is all about high risks and not just high returns. Am I comfortable with that high risk? So, a lot of times I ask this question that if you are aggressive, how would you feel when your portfolio; after you invest, goes down 50 percent? Five-zero.

But my question out there is, that lets say that someone out there is 60 years old is fine with the risk and there is no outer timeline because now, this is a retirement saving. I am 60, I am fine with risk, I don’t have a timeline to it but being 100 percent equity might not be the right strategy because it is a retirement fund which in case having a 100 percent equity fund might not be too aggressive a portfolio?

Amit: Yes, that’s where if it is a retirement portfolio, the purpose of which is to generate regular income from the portfolio. Then that portion cannot be in equity.

That is my question. Aggressive versus passive, is it age dependent?

Amit: Again, not necessarily because a 60-year-old who is requiring income from that portfolio, would have a different requirement whereas another 60-year-old who is a pensioner getting pension. This portfolio is for the second-generation therefore the age may not be that important but the purpose for which the investments are being made becomes critical. That is the time to goal.

Gaurav: So here it is, let’s take an example. There is a 32-year-old Indian male. One, unmarried, living in a city, working for a foreign bank. Father-doctor, mother- architect. IIM, IIT, his asset allocation vis-à-vis somebody who has dependent parents, married, two kids, sister to get married in 3 years’ time, 32 -year-old Indian male, an Arts graduate, working in the government. Both 32-year-old males living in India, can they have the same asset allocation? They should not, right? Because one has dependent parents, sister to get married and a family. Other one is, the kind of qualification. The first person has job insecurity, highly qualified and the second one is, complete job security but it eventually would come down to what are you saving.

Would that be the answer to the next question as well which is a mix of debt and equity and other asset classes? An almost similar answer to that?

Gaurav: But I’ll come back to that with the 60-year-old to answer this question. Let’s say a 60-year-old is somebody who needs income from retirement portfolio. There is no other source of income. But now, at 60 years, I need income starting this month and every month after that for a very long period till I am alive. Yeah? So, my goal is not short term. My goal is short, medium and long-term. I also need rising income because my cost of living will go up because of inflation. So, a retired person need not have a conservative portfolio only that may not serve the purpose. You may need a combination of conservative and aggressive investments within the portfolio.

It is has to be very tailor-made?

Gaurav: It has to be very tailor-made. So, the size of the portfolio and the amount of money that you need as income, expected inflation, expected longevity, all these factors will also play.

While it will always be a person-specific event and a situation-specific answer, is there a general rule of thumb for a portfolio being too aggressive, too passive or more equity-oriented or more debt-oriented? Maybe based on the age, maybe based on the number of the years that the portfolio has to serve the person?

Gaurav: Which I already mentioned in the beginning, seven to nine years and beyond, equity as an asset allocation. Between three-four or up to seven years of combination of debt equity. That is rule of the thumb. So, now, there could be some plaza routes of six to eight or some will say eight to 10 or whatever. At the end of the day, that is rule of the thumb. Now, that you have to apply to yourself so the rule of the thumb is general but from that you have to adapt to yourself. If you are saying that the rule of the thumb should be something that everybody can adopt, that cannot happen.

Would you now start advising them to have also, aside of the other mixes, a small mix of funds which are high-cost funds versus some funds which are low-cost especially, in a large-cap category because outperformance is difficult with TER and all of that. Is that a legitimate way of looking at the portfolio?

Gaurav: It should’ve always been like that. In every downturn, everybody will start talking about passive funds and every upturn, they’ll start about ‘we can generate alpha.’ So, both should’ve been there in your portfolio from the beginning.

Irrespective of when the timing works?

Gaurav: Exactly. Because your core portfolio should be why less equity and we know equity by nature is not linear and a debt fund, typically a Nifty or a Sensex fund, is less volatile compared to. Hence, that should form a core. Now, that core to be big or small depending on and then you should have those alpha generating funds which is going to take you to upper levels. So, this should have been there at any given point of time and if you look at it historically, whether it is fund managers or fund houses or whatever. In every downturn, passive comes in because it is difficult to generate alpha and, in every upturn, alpha comes in. There is nothing new, absolutely nothing new.

But that is just because of the number of options available which are larger than what they were; are they now finding a higher space if not in the actual portfolio than in the mind? And are you also recommending that to your clients?

Amit: Yes, so first of all, as the mind space is concerned, yes. Because of so much discussions around, the mind space is occupied more now. But did it deserve a place in the portfolio? Yes. Irrespective of whether earlier the benchmark was price return index or today it is total returns index. It doesn’t really matter. What has changed, it is the benchmark that has changed. But it is still difficult to beat an index fund. It is the same now also because index fund was always a total return index fund. Dividends where added back. It was just the benchmark which has become TRI. Funds were always TRI or the total return funds. So that’s not really changed and now acceptance has gone up because of the mind space, because of the discussion. Earlier, people stayed away from buying index. Why do I need a mutual fund if I have to only buy an index? Somehow, we love outperformance. Somehow, we want to beat every other person. So, we are not happy with the averages. That’s a psychological factor more than anything else.

But it is advisable to have some mix of funds as well?

Gaurav: Yes, it is advisable. If you want to do ETF or passive funds, it is okay. Depending on its an operational ease, ETF may still have further costs of this thing because if you are able to negotiate the brokerage better and there the tracking error is virtually negligible but here, it is. But, that’s more of ease of operation. Amount of money you are putting in because so many times, stockbroker—unless you’re doing it on your own are not interested in Rs 1,000 or Rs 5,000 kind of a transaction every month so then, to that extent, you have to take that risk.

The other question that a lot of people would ask when they are looking at their portfolio is whether my portfolio is focused on specific goals and therefore, I have eight goals or therefore I have eight or 12 funds, etc or is it just completely random? I do not know the right answer to this. Is it too much to think of when we are looking- whether the portfolio is goal focused or is it okay to have a random portfolio? How do you analyse these?

Gaurav: Ideally, so here it is. Overall, the portfolio is one, but the constituents; you will have to look at constituents otherwise it will go wrong. It may happen that you may decide a particular fund for two goals. Whether you really want two folios for the same fund say, ABC equity fund or do I want to have the ABC equity fund for one goal or another ABC equity fund for a second goal that’s more of ease of operation and playing with mind. Ideally, you can have one and say 10,000 for this, 6,000 for this and 4,000. But a common mind would not be able to do it and hence, purely for ease of operation; as in, paper work will increase in many folds and take that call or let your adviser advise you. But ideally, have allocation based on goals whether you consolidate or.

That’s what I was going to ask. Will allocation based on goals help? A lot of times, people tend to do that. I intended to do that as well. I have some money, let me put that in a mutual fund. It’s not based on goal, without any strategy behind it. Is that also okay or is it always advisable as far as possible to put in money with some thought in mind so that I stick to the fund till the time the goal is met? Is there a way of analysing the portfolio?

Gaurav: It depends on how wealthy you are. If you have a lot of money do that.

Amit: So, what happens is, when you don’t have a purpose in mind, then you tend to look at the market. Then, because the market in short term is so unpredictable, we tend to make mistakes by reacting to what’s happening in the market. Rather than that, if the investments are made for the goals, then we are more likely to stick with those investments and not tinker around a lot. That’s one. Number two, what Guarav was mentioning about the ABC fund for one goal and same ABC fund for another goal. Do I need two separate folios or do I not? There is a concept in psychology called mental accounting. So, you assign your investments according to various boxes that you’ve created in your mind. In such a case, what happens is, if I have allocated some money for my daughter’s education, I am not likely to play around with that money. That is serious money. On the other hand, if I have invested on the same set of funds, for a vacation goal, I may play around with that money. But if I’ve kept both together, chances are that my daughter’s education money may get utilised. So, for a lot of people, only from discipline point of view, these kinds of boxes may work to control the urge to splurge.

Within equity, is there a generalised rule of thumb? I know in equity portfolios for example, when we talk, we keep looking at the fund manager’s portfolios and there is a judicious mix of large, mid and small. What about mutual fund portfolios? Should there be a judicious mix? Is there a generalised bifurcation?

Amit: So, I would actually go with this that if you are looking at keeping the control in your hand versus you are giving the control to the fund manager. That’s the decision. If you want to keep the control to yourself, then decide on large-, mid- and small-cap funds separately. If you don’t want to decide on market cap, then invest in a multi cap fund. Make it that simple. That’s one part. The second part of the answer is, should there be a fixed percentage or some guideline or some thumb rule about percentage? Typically, my approach would be, because I am more of a conservative guy by nature. My approach would be, you start with a low-risk portfolio and build your risk up as per your need. Don’t start with a risky portfolio and bring the risk down. Because, psychologically, if I am unable to handle that risk, that is going to be a torture and investment is not supposed to be torture, it is meant for the peace of mind.

By a low risk you mean have a higher allocation for large-cap funds?

Amit: Yes, but even for passive funds. You may start with index fund, then large-cap funds and then go up.

Gaurav: Among all, the least risk is passive, because that kind is replicating the benchmark.

So, have a higher proportion of these funds? A higher proportion would mean when you are starting off with more than 50 percent or more than 60 percent?

Gaurav: It would be more than 50 percent, and in some cases, it could be more than 100 percent large cap.

Okay, when you’re starting off absolutely? And then you can build up?

Gaurav: Yes, then build up.

Okay, someone who has been in the markets for 10, 15, 20 years and has a mutual fund portfolio of 10, 15, 20 years is now looking to realign. Does that mix change? And again, we do not know the end goal so it will depend. But as a generalised rule of thumb, or something?

Amit: So, what your experience and education and knowledge about investing per se, if you spend 10-15 years in the market, then your understanding of the risk has improved. And to that extent, you’ll be able to evaluate the risk much better than no risk. To that extent, you can afford to build the risk. So, when you take risk, we always hear calculated risk. Now, that calculated only comes from that knowledge and education. So that’s why, you don’t even take calculated risks because you can’t calculate in the beginning and after 10-15 years of experience, you should be able to do that. So, you build up the risk. It is fair.

Gaurav: As my personal experience, one is, I am too scared to invest in debt products. So, I only do equity. That is a personal call. But second thing is, I always want top quality. So, I rarely go, in my case, beyond large cap. So, for years, I’ve been doing. I am 50 now. I started investing in equity directly when I was 18 or something and I’ve been doing it. But I only want top notch companies. Now, again, my mindset, but the general rule and experience is, mid and small haven’t given me that high extra returns by doing it. But, that’s my thought process. I am completely fine with volatility. In profession, I’ve seen twice or thrice more than 50 percent fall and it bouncing back so, may it be during Harshad Mehta time or tech bubble or even recently, 21,000 to 8,000 or anything, it doesn’t bother me. But when it is rising, it is mid and small which will go up fast, but in fall, the ability to fall and bounce back with large cap companies is much more.

When the person is trying to analyse the portfolio how do you see if the portfolio is sufficiently providing for retirement?

Gaurav: The day you take up your first occupation. Because then you are going to retire, right? If you don’t take up any occupation, then there is no question of retirement.

So, are you saying that at age 30 you start providing some for your retirement?

Gaurav: Yes, do that. So apart from you’re saying I have EPF and EPS option whatever, but you’re not building any portfolio. Anything is a habit. So, once I have a habit that I am going to set aside, it can be as little as Rs 500, keep doing that and if possible, try and increase that amount by 5 to 10 percent every year. You will be able to accommodate other goals, other responsibilities, other splurging automatically. Start doing that because you’re doing longer time and as a practitioner, the experiences while you’re single, when you are young, you are able to do it more easily. As you will grow, you may have a home loan, there will be marriage, then there will be dependence in terms of children. Towards 40-45, the Indian society generally would have some dependency from parents—normally, middle-class families, higher-class may not have. At that point of time, if you are not used to doing retirement, then retirement funding takes a beating and suddenly you are at 50-55. So, start at Rs 500, won’t matter. That is my experience.

Amit: I’ll agree. There is another advantage and we talk a lot about power of compounding. The earlier you start, even at a lower rate of return, you are able to build a sizable corpus. So, without even taking much risk, you can build a sizable retirement portfolio. But the moment you are in the 50s and that’s when you start, the rate of return required would be immensely high. You have not invested which means you don’t understand investing and now you are facing a situation where only a high-risk portfolio may help you and you have a low risk portfolio and you have lost it. So, earlier the better.

At 30, let’s say my income is Rs 50,000 a month in hand. There are expenses that I have to do, there are some goals in which I am investing. I may want to buy a car, I have holidays, etc. There is a limited sum that I have. Do I also have to provide for retirement from there itself or do I first think of cold-based investing for my immediate near-term goals and once my income expands, is should I start providing for retirement? Because, if I do everything from my Rs 50,000 salary, I won’t have anything to spend. How does one live life?

Gaurav: So please splurge. Don’t hold that back but if somebody is saying that from Rs 50,000 income a month you can’t set aside Rs 500 for retirement and other things, I don’t think that is, I mean, it is a mutual fund show but otherwise, post office recurring deposit you can start with Rs 5, minimum. I am just saying it is a habit. So, it is like, I am stout suppose and if I decide that tomorrow, I want to run for 10 kilometers, I am gone. But I say, I’d do 100 meters, how long will I keep doing 100 meters? Eventually I will increase. So, it is ‘develop, get into the habit’ and you will increment. Our experiences with people is that they will come back and say that, ‘thoda amount bada dena, Gaurav, thoda amount bada dena. Yeh toh aasaan ho gaya’ (Increase a little amount Gaurav, increase a little amount. It has become easier). Whether you are taking home Rs 49,500 or Rs 50,000 isn’t going to make a drastic difference.

Amit: If it is the question of splurge and I just want to highlight two points. It will make the discussion lighter also. Life is actually a balance between two movies. One movie is ‘Zindagi Na Milegi Dobara’ and second one is ‘Tara Rum Pum’. In Tara Rum Pum, the hero splurges and then lands into trouble. In Zindagi Na Milegi Dobara he says, ‘I’ll slog so that I can enjoy retirement’. Life cannot be lived in either way. It has to be lived between the two.

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