No return-minded investor can afford to ignore mutual funds. But the key to happy endings in mf stories is the ability to pick the right funds, and maintain a balanced fund-portfolio.

By Roshni Jayakar

Wrong question: What are the top performing funds?
Right question: What am I trying to accomplish with my mutual fund portfolio?

If (market) history were in the habit of repeating itself, investing in mutual funds would be easy. Investors could buy into the previous year's top funds, confident in the belief that these will, in all likelihood, repeat their past performance. The market, though, does not respect history.

Ignore this simple fact and you can sayonara your investment. Put otherwise, if your investment-decision is based on a top funds of 1999-2000 listing you caught sight of in a magazine, let's just say your portfolio's performance in the coming months may not exactly be termed 'winning'.

Not convinced? Picture this: if you were an investor in an infotech fund you probably had that top-of-the-world feeling in early 2000 when a few infotech funds zoomed to the top. The Kothari Pioneer Infotech fund, for instance, posted a 284 per cent one-year return in terms of Net Asset Value (NAV). But with the market being unkind to infotech-stocks-and infotech funds-over the last two months, several of yesterday's top-funds have seen their year-to-date (between January and April, 2000) returns plummet to the other side of zero: for the Kothari Pioneer Infotech fund, this figure (on April 30, 2000) was 11. 23 per cent.

There's a pattern to this. Rewind to the advertising blitzkrieg unleashed by a few Asset Management Companies (AMCs) in February, 2000. The lure? Returns in excess of 40 per cent for the preceding three months. Or 125 per cent, if annualised. Today, with the market in a correction mode, the funds managed by these AMCs are amongst those displaying the largest drop in NAVs. Among these are four funds from the SBI fund family-Magnum it, Magnum Multiplier Plus, Magnum Equity, and Magnum Balanced.

There's a moral somewhere in this mess. A fund's vulnerability is, to a large extent, a function of how it is positioned. If the AMC sells the fund aggressively, emphasising its short-term performance, it attracts investors looking for the quick-buck. While funds of this nature rule the roost in a bull market, they take the largest risks, and, consequently, fare the worst in a bear market. The moral? Those who live by the bull die by it.

The timing of this correction, from the perspective of the typical investor in mutual funds, couldn't have been worse. Till late 1998, many investors were wary about mutual funds. Then, emboldened by the fact that a few funds were registering handsome returns, and encouraged by the fact that Budget 99 made returns from mutual funds tax-free, they moved from bank deposits and debentures to mutual funds. Today, many such investors are seeing the value of their mutual fund portfolios-especially investments made since January, 2000 in aggressive equity funds, and sector specific ones-erode.

So, what should investors do? They cannot go by cyclical trends as mutual funds do not have a long history in India and haven't gone through enough market cycles to enable the drawing of intelligent inferences. And, decisions based on past performance of funds too are, as has been proved, short-sighted. Avers Rajiv Vij, 33, CEO, Templeton Asset Management India: ''Redeeming equity funds that have witnessed a drop in NAV is the last thing you should be doing. If you have a long-term view, and the guts to back it, you should buy more on the downturn.'' Our recommended course of action: start with the basics; what is it you'd like your investment in mutual funds to do for you?

Goals, especially financial ones, vary from individual to individual. They are a function of the individual's age, lifestyle, level of financial independence, income, expenses, and a slew of other aspects.

Rebalancing

Typically though, your investment-plan in mutual funds, will fall into one of three categories: aggressive, moderate, or conservative.

The aggressive plan is for investors who are in their prime earning years-anything between 22 and 40 years in terms of age-and are willing to take a few risks in the interests of long-term growth.

If you satisfy this criteria, you should allocate between 60 and 70 per cent of the amount that you wish to invest in mutual funds in growth or equity funds, 20 per cent in balanced funds, and 10 per cent in short-term, or money-market funds.

The moderate investment plan is for people who are in the 40 to 55 years age-group. If you belong to this age group, and seek a regular source of income, as well as a modicum of growth and risk, you should invest about 40 per cent of the total amount that you wish to invest in mutual funds in equity or growth funds, between 35 and 50 per cent of it in balanced and income funds, and between 10 and 25 per cent of the money in money-market or short-term funds.

The conservative plan is for those individuals who are either contemplating retirement, or are already retired. They need to preserve their original capital, and, earn regularly. If you belong to this category, invest between 15 and 20 per cent of the total amount you have earmarked for mutual funds in growth funds, 50 per cent in income funds, and the rest in money-market funds.

The objective of this exercise is to balance your investments between various categories of mutual funds. However, review your portfolio of investments every quarter, and whenever there is a change either in your personal financial circumstances, or in external factors like the equity market or interest rates.

If your exposure to debt schemes , for instance, is high, the slide in the NAVs of equity funds provides an ideal opportunity for you to shift some of your investments in debt funds to equity funds. Or, if you anticipated the 14-month bull run (between November, 1998, and February, 2000), and shifted assets from debt to equity schemes to benefit from it, this could be the right time to shift some right back to the former.

Clearly, this is the time to reshuffle your portfolio and achieve a new balance between debt and equity schemes. Some AMCs offer transfer plans between the range of funds they manage to suit investor-needs. Thus, an investor could transfer a fixed amount every month from a debt fund to a diversified equity one, or even a sector specific one.

However, investors should ensure that the original objective that influenced their investment in the fund does not get diluted during such transfers. Says Ajai Kaul, 39, CEO, Alliance Capital Asset Management: ''Investors must ensure that what they buy, in terms of fund objective, while investing in a fund scheme, is what they get. That there are no surprises later.''

Diversifying your portfolio

Diversification is an universally-recognised antidote to risk. Bond funds do not offer a range of diversification options. However, even there, an investor who chooses a fund that targets low quality debt may end up with higher returns (at a higher risk). But equity funds are different. How can you build a diversified portfolio of equity funds?

Diversification takes place at two levels: one, an individual can choose to invest in value-oriented funds or in growth-oriented ones; and two, within each, the investor can choose funds that have an aggressive approach or a conservative one. Thus, the investor can choose between the aggressive or conservative growth funds, and the aggressive or conservative value funds. Of the more than 300 funds that investors can choose to invest in, there isn't a single aggressive value fund: most of them are aggressive growth funds. Still, apportioning your investment across the various categories that exist can serve as an effective risk-control mechanism.

Diversifying your portfolio isn't something that can be achieved by simply apportioning your investment between several aggressive growth funds. The reason? Between 40 and 80 per cent of the assets under their management reside in infotech stocks. Thus, infotech stocks account for 67 per cent of Birla Advantage's portfolio; and 40 per cent of Alliance Equity's and ICICI Power's. And the top five holdings of these funds and the top five holdings of the sector fund from the same fund house are similar. Thus, if you seek to diversify your portfolio by investing in diversified portfolio funds you should first check out the holdings of the latter. Agrees Vij of Templeton: ''Diversification does not mean investing in sector funds as well as a diversified equity fund having almost similar scrips.''

It also makes sense for an investor to understand the fund manager's approach to diversification. Bharat Shah of Birla Mutual, for instance, believes fundamentally strong infotech companies will always do well, and interprets diversification as buying into several such companies. Some investors could agree with that definition of diversification. Others may not.

Excellent returns in a particular sector or company may result in individual investors getting carried away and investing all their money in a single sector, or, worse, a single stock.

Fund managers, too, may be tempted to adopt this approach to meet performance objectives. They, however, have to achieve a balance between the business objectives and fiduciary responsibilities.

From an investor's perspective, it probably makes sense to pick funds that have a portfolio which is consistently diversified across sectors and stocks. Typical examples of such funds are Kothari Pioneer Blue-chip, Zurich India Capital Builder, and Sundaram Growth.

Even when the infotech boom was on, these funds didn't go overboard on the sector. Thus, when the market turned south, they lost less than most others of their ilk did. Kothari Pioneer's holdings on March 31, 2000 comprised 28 per cent in software stocks, 7.6 per cent in FMCG stocks, and 31 per cent in cash. The result? The fund was well-placed to pick up stocks cheap post the meltdown. And Zurich India Capital Builder did not count a single software scrip among its holdings on March 31, 2000. Explains S.V. Prasad, 40, CEO, Zurich Asset Management India: ''These (scrips) do not satisfy the fund's objectives of staying invested at reasonable prices.''

There's another reason why the investor in search of a diversified portfolio should approach tech-funds warily. In a market driven by technology scrips, not many funds are managed by people who understand technology. In most cases, plain vanilla fund managers, who managed money by betting on Hindustan Lever or Reliance Industries when these were the market-favourites, have shifted to infotech scrips.

Investing in a volatile market

Passing on hot mutual fund tips seems to have superseded the traditional market-player's pastime of sharing hot stock tips. However, the long-term success of a fund depends on the presence of a well thought out strategy, and the discipline to persevere with this strategy through volatile times. Agrees U.R. Bhat, 45, CEO, Jardine Fleming Asset Management: ''It is best to avoid the temptation to time the market.''

The reasons? Market timers, who invest in stocks only at the most opportune time, run the risk of being out of the market when it actually peaks. And two, over the long-term-one year for debt funds, and between five and 10 years for equity ones-most funds that have similar objectives end up with returns in the same range.

The ideal approach to investing wisely in a volatile market comprises two steps. One, identify the funds in which you wish to invest on the basis of the investment style of the fund manager, track record of the AMC, and your own comfort level. Two, this done, opt for the Systematic Investment Plan (sip), which is also referred to as rupee-cost-averaging, that most AMCs offer.

The sip allows investors to stay a step ahead of market fluctuations, by investing a fixed amount of money every quarter (or month) in additional units of the fund. Since the amount that an investor puts in every month is a constant, he or she will buy more units when the price is low; fewer units when the price is high. Therefore, the average cost per unit will always be less than the average sale price per unit irrespective of the market rising or falling.

The numbers speak for the efficacy of the sip. According to Value Research, a New Delhi-based company that tracks the performance of mutual funds, over the three year period ended March 31, 2000, the average return on new equity funds that have a track-record of more than three years, was 32 per cent. For the same funds, under a notional sip (sip quantum: Rs 1,000 a month), the return was a whopping 63 per cent.

Thus, while the average annual return for the Templeton India Growth Fund over three years was only 13 per cent, the corresponding figure under the Systematic Investment Plan was 34 per cent. Says Kaul of Alliance Capital: ''If you opt for sip, you will always outperform the fund manager.''

Choosing the right number of funds

Some people buy mutual funds as if they were collecting art. When they find something that they like, they buy it. And, when they find something else they like, they buy that too. The next thing they realise is that they have more than a dozen funds in their portfolio.

Such an approach to owning funds is not investing. It's collecting. Owning 11 funds is not 11 times better than owning only one.

The performance of most growth funds, for instance, is similar. That isn't surprising as they, almost always, have the same stocks in their portfolio. There is no point in investing in the same stocks through a variety of funds. All of them either perform well. Or all of them perform badly.

Therefore, if you think you are reducing risk by investing in several funds, but choose funds of a similar nature, you aren't meeting your initial investment objective.

If that's not reason enough to avoid scattering your portfolio among too many funds, think of the administrative problems investing in too many will cause. The ideal number of mutual funds to own? Our advise: a maximum of six.

Zurich AMC's Prasad thinks even that is way too many. ''Handling more than three funds is operationally inconvenient if you do not have very large funds for investment,'' he explains. For, even to assemble a portfolio of six funds, you may have had to buy from a minimum of three fund houses.

The result? A blizzard of paper work, account statements, and quarterly portfolio disclosures that make managing your mutual funds portfolio hell.

Choose a few funds, pick them well-with a dollop of conservatism if your need is short-term returns; and a dash of aggressiveness if you are looking at long-term returns-and continuously monitor their performance closely, juggling your investments to maintain the ideal balance. Do this and you will not have to ride-out bull-runs or duck bear-swipes.

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