The number of man-hours lost in trying to figure out the market bottom would be far better utilised if investors spent the same amount of time on a more profitable exercise,which is to try and identify a vehicle that will help them create wealth and meet their long-term goals. Among mutual funds,diversified equity funds are best suited for meeting long-term investment goals. The most basic diversified equity fund attempts to beat its benchmark by nurturing a portfolio that has its footprints in a large number of sectors and stocks. The portfolio construction reflects the primary objective of diversification. When judging the performance of a mutual fund,it is important not just to look at absolute performance in isolation,but to compare the funds performance vis-à-vis that of its benchmark index. A simple example would help clarify this. Suppose that a year ago I had invested in a fund that has given a return of 75 per cent. Would that make this fund a must-buy? Not necessarily. I would also look at the funds benchmark (lets say its the Nifty) to see how it has performed. If the benchmark has given a return of 79 per cent,then the fund has actually provided a return that is lower than the acceptable minimum. Thus one would have no hesitation in passing over this fund. This simplicity of matching and comparing performance is not readily available for other categories such as sector funds and thematic funds. Secondly,very often the mutual fund industry advertises the high growth that has come from a particular sector or a particular market capitalisation. But do not look at returns in isolation; also pay attention to the level of volatility in the preferred sector. Thus identifying a sector that has given high returns in the last few months or so is a dangerous premise on which to buy a fund. One can never tell when the preferred sector will run out of steam,and when leading fund managers will no longer treat it as a preferred sector. Besides,when you invest in a diversified equity fund,the fund manager is at full liberty to invest in the momentum sector to the extent that he desires. He is also at liberty to exit the sector when he so desires. Thus,instead of investing in a narrow sector or theme,it makes more sense to invest in a fund that casts its net wide and can capture the gains from a large number of sectors and stocks. A diversified equity fund would perhaps provide a lower return than the momentum sector of the time,but the risk borne would also be much lower. Should you invest by market cap? A popular concept floated by the fund management industry is investment in capitalisation bands. But if you cared to look beyond the hype,what affects returns is not the capitalisation band but the quality of holdings that the fund invests in. Sure,sometimes midcaps run ahead and at other times large caps. But over a long time frame,all market caps enjoy their moment under the sun. If you invest in a diversified equity fund,then the fund manager would in any case have an exposure to stocks across market caps and would thus be able to capture those gains. The only deterrent could be lack of liquidity (especially in small cap stocks). But that again indicates the higher risk involved in funds dedicated to a particular market capitalisation. In your equity portfolio,how much should you allocate to diversified equity funds? There is no single strategy that fits all. The answer depends on ones risk appetite,portfolio size and myriad other details. It would be best to sit down with a financial planner and get a handle on this number. But you should insist that the allocation to diversified equity funds not be below 40 per cent and not exceed 75 per cent of all equity mutual fund investments. If your holding in diversified equity funds is below 40 per cent,your portfolio would lack solidity and would become speculation heavy. If equity diversified funds comprise more than 75 per cent,the portfolio would be too narrowly focussed. To reiterate,its pointless to check out time,sector or capitalisation while making investment decisions. The markets are attractive for investors who have an adequately long time frame. Choose four or five quality diversified funds and get on with your life. Some of the better diversified equity funds are Reliance Regular Savings Equity,HDFC Equity,and Morgan Stanley A.C.E. The author is a Kolkata-based mutual fund analyst. Email: wiseprasun@gmail.com
