How to pick right type of funds for your portfolio

Investors are often faced with a dilemma when it comes to investing in mutual funds, which are the right funds for my portfolio? There is a plethora of options available, with over 40 Asset Management Companies (AMCs), multiple fund categories and in many cases multiple funds within each category from a single AMC.

It’s like walking into a grocery store to pick up a carton of milk where you find products from multiple manufactures and different types like full fat, 2% fat, no fat, skimmed, toned, etc. This by no means is an easy task for the most experienced shoppers (investors). Everyone has preferences, but you don’t truly know if those products are indeed the best for you.

Sebi has recently introduced a fund categorisation system which aims to help make this job easier for investors, by introducing a standardised categorisation and only a single fund in each category by every fund house. Yet there are 36 categories and multiple funds within each category, which still makes it a fairly arduous task for a lay investor on the street to identify suitable funds for their portfolio.

Here are some basic investing principles that can go a long way in aiding investors make these decisions:

Identify your investment objectives

The starting point for building any successful investment portfolio is to understand your investment objectives- What are you return expectations, how much risk are you willing to take, what are your short-term and long-term goals, how long can you invest. It is imperative that every investor draw up a list of these in as much detail as possible.

These parameters will go a long way in deciding the right asset allocation for your portfolio.

For instance, if an investor is looking to retire/or needs a large portion of the money within the next 3-5 years, ideally a majority of their portfolio should be in asset classes like fixed income which come with lower risk. But an investor who is 25-30 years away from retirement can look to put majority money in equity and only a smaller proportion in fixed income.

Choosing the right fund types

Once the overall asset allocation framework has been decided, the next step would be to identify the fund categories you should be invested in. Each asset class has a variety of funds categories available that typically vary in their risk return profiles and suitable investment time horizon. So choose wisely!

Fixed income allocation can vary between Liquid Funds where you could invest for as little as day to Short Term Bond funds where your investment horizon should be 1-3 years or Medium to Long Bond Funds where you should have at least a 3-year horizon.

Similarly equity funds can serve varying needs, large cap funds the most common funds are the least volatile and should be held for at least 3-5 years to small cap funds which can give you staggering returns but come with increased risk and thus should ideally invested into with a 7-10 year time frame. Choose the fund types that match your risk-return objectives and intended investment horizon.

Which funds?

Once the suitable asset allocation and fund categories have been identified, here is where the choice gets even trickier.

With over 40 Asset Managers and each of them with fund offerings in the major categories; it’s a gargantuan task picking the right funds for your portfolio. Ideally you wouldn’t want to hold more than a couple of funds per category. A few pointers to keep in mind:

1. Don’t make decisions purely driven by past performance. Even if you do so, look at the consistency of returns over different time periods.

2. Pay attention to the team running the strategy and not just fund manager. An experienced team that has worked together for longer periods tends to deliver more consistent results.

3. Pay attention to the style of the fund, different managers have different styles of management. You can witness this from the Style Box of the fund. Mixing different fund managers styles in a portfolio gives you additional diversification benefits.

These are some general rules to follow when constructing your portfolio. If you think you do not have the time or the understanding to do this yourself, always consult a Financial Advisor.

Once you have built a portfolio of funds, monitor it regularly but don’t make changes too often. Ideally, only if your investment objectives have changed or the mandate of fund has changed or the fund has underperformed for prolonged periods, only then should you be looking to rejig your portfolio.

(The writer is Director Manager Research at Morningstar Investment Adviser India)