top of page
PC - Logo.png

There are hundreds of schemes across different categories of mutual funds. It is hard for an investor to identify which scheme is better. It is not about the highest returns; it is about a scheme or combination of schemes that will help in achieving an investor's financial objective. In this article, we will explore a lot of information from knowing the basics to creating investment portfolios using mutual funds.


Investing in Mutual Funds

What are mutual funds?

A mutual fund is a pool of funds from many investors that is used by a fund manager to meet a certain investment objective.


Are mutual funds safe?

The next question investor often has is whether mutual funds are safe. During the 90s when the Harshad Mehta scam happened followed by US 64 disaster, a whole generation lost faith in the equity market.


A lot of cleaning has been done in the last three decades. The equity market regulator, SEBI has progressively made mutual fund investments safe for the investor.


SEBI understands that Indian investors are not financially savvy. All the regulations related to mutual funds can be categorised as biased towards retail investors. Regulations cannot protect the movement of the market; an investor must guard himself or herself against any market movement. You cannot blame the regulator for a general decline in markets and the erosion of investment portfolios. You have to do your homework, anyways.


Types of mutual funds

In India, mutual funds are available in three categories i.e., debt, equity, and gold. Soon we may be looking at the fourth category, real estate in the form of real estate investment trusts (REITs).

  1. Debt funds are for income; in simple terms, you can see them as a substitute for your fixed deposit.

  2. Equity funds are used for long-term investing.

  3. Gold provides a good hedge against inflation.


There are many debt instruments in India including provident fund, PPF fixed deposit, NSE and others. The benefit of investing in a debt mutual fund is firstly liquidity. A lot of government-sponsored debt instruments including provident funds are not liquid. Another benefit of debt mutual funds is the diversification benefit. Investing in one debt mutual fund gives you access to a broad range of bonds across different sectors, including government bonds.


There are many types of debt mutual funds. Broadly they are classified across four categories.

  1. The first category is a liquid fund. A liquid fund invests in corporate deposits and government treasuries. Across all categories, the liquid fund is the least volatile.

  2. The other categories include ultra-short-term debt funds and short-term debt funds. These funds invest in corporate debt and government debt maturing in 1 to 3 years. When RBI makes changes, liquid funds will be the least impacted.

  3. The next category is medium and long-term debt funds. As the name suggests these funds invest in medium-duration and long-term duration i.e., more than five years of maturity. When RBI makes changes to the interest rate, these funds are severely impacted.

  4. The last one is the arbitrage fund. Although arbitrage funds are equity funds they behave like liquid funds. Since these are equity category funds, taxation of equity is applied i.e., in the short-term 15% and in the long-term 10%. This category would be the most tax efficient for people in high tax brackets.


There is an inverse relationship between interest rates and the duration of a mutual fund. A medium and long-term debt fund will fluctuate a lot when there is interest rate movement. A lot of retired people who want to create cash flows based on their retirement needs may evaluate medium and long-term debt funds.


Let’s discuss the equity category now.


There are broadly four categories of equity mutual funds. The other categories such as thematic, small and mid, large, and mid etc. are just slices and dice of these categories.


Large-cap funds

Large-cap funds invest in the top hundred companies by market capitalisation in India. There is a lot of debate that index funds are better in this category than actively managed funds. An index fund as the name suggests is passively managed and there is no fund manager whereas an actively managed fund has a fund manager and thus a higher fee is applicable.


Midcap funds

These funds invest in the top hundred to 250 companies by market capitalisation. In this category, a fund manager has a crucial role. This is the reason performance within the Midcap category can be very wide. Wrong selection in this category can be very costly to the investor.


Small-cap funds

These funds invest in the top 250 to 500 companies by market capitalisation. In this category also a fund manager’s role is critical. Relying on index funds can backfire.


Multi-cap category

These funds invest across categories irrespective of the market capitalisation which is a combination of large-cap, mid-cap and small-cap.


Indian mutual fund industry offers debt, equity, and gold mutual funds. What should be the combination across all these for the investor? Should the debt be high, or Equity be high? what about gold?


You need to know whether you are an aggressive, moderate, or conservative investor.

Do not assume that if you are earning well, you are aggressive, and do not assume that if you are not earning well, you are conservative.


You must reflect on your risk profile from two perspectives. One has your level of income and asset base and on the other side your comfort with volatility.


An aggressive investor is a long-term investor and very comfortable with volatility. Similarly, a moderate investor is a long-term investor but is not too comfortable with volatility. A conservative investor is an investor with an extremely low level of comfort with portfolio volatility.


Plan first

The first task you need to perform is to identify your investment objective also called financial goals. This will help you understand the time horizon that you have to invest in.

Retirement could be a long-term goal say 15-20 years from now, whereas buying a car could be a short-term goal. Once you have identified your goals and time horizon, you will have clarity in terms of which mutual fund to select.


Based on your risk profile and your investment objective, a combination of equity, debt and gold can be selected. A conservative investor can have a minimum investment of 25% into equity and 75% in combination with debt and gold. This changes to 75% in equity and 25% in debt and gold for an aggressive investor.


This is a broad guideline and not an answer; even if you are an aggressive investor, but you have a short-term goal, say you’re retiring in the next five years, you should not invest 75% in equity. Similarly, if you are a conservative investor, and you have a long time to achieve your objective, you should not shy away from not investing in equity.


‘Mutual funds Sahi Hai’ is only for those people who partner with the right fund managers. A careful assessment to select the right fund managers is key to ‘mutual fund Sahi Hai’.


At monthlysip.com, we use our proprietary models to identify mutual funds across various categories. We reach out to the fund managers and study the underlying assets of funds to understand whether the fund's inclusion is appropriate for the investors.

All investors are different, every investment is unique. Before deciding on the number of mutual funds, you have to identify your financial goals and invest accordingly.


How many Mutual Funds are good enough in a portfolio

There is no perfect portfolio that would work for everyone. You have to be prepared by doing proper research and finding out what works for you.


Therefore, unless you are very well versed with the markets and have expertise in mutual funds, a good rule of thumb would be to own.

  • In a debt category, one or two funds are good. You must reflect on your time horizon and associated taxation.

  • You can select one index fund or a combination of two funds in a large-cap category. If you add another fund, there will be a high level of overlap in the large-cap portfolio.

  • You should invest in two small-cap and two mid-cap funds. Usually, the overlap in these categories is low if the chosen funds have a different strategy (value/growth).

  • In the case of a foreign mutual fund, one fund is fine as far as the underlying is an index of a foreign country (NASDAQ/NYSE).

A few months leading up to election time are filled with higher volatility which over time, especially after the election, subsides. In the last so many years market has behaved, rationally or irrationally, based on the comfort of political stability.


Election Year and the Investment Return

There is a weak correlation between Lok Sabha election and investment return. However, there is a high correlation between business profitability and investment return. Similarly, state elections are more relevant to local businesses impacting business profitability. A lot of state-level politics can have an impact on running businesses/factories in that state.

 

If you remember many years back, West Bengal did not let Tata manufacture Nano cars in the state. Tata Group had no choice but to leave West Bengal. It’s a different matter that Tata Group realised that Nano was a bad decision but still the entire event created an image of West Bengal as not a business-friendly state.

 

Investment community preference is towards political stability, irrespective of which party forms the government. As part of a stable government, we need a party to win majority Lok Sabha seats and that will ensure the next five years of stability. In a few days, we will start hearing a lot of exit polls and what each media house thinks. These exit poll results can have a short-term effect on markets especially if the indication is towards an unstable government.

 

I have no idea who will be forming the government, and I am pretty sure no one does. We also suffer from recency bias. We assume that 2019 will be repeated but who knows what. Atal Bihari Vajpayee was a great leader who made India a nuclear state and won the Kargil war but lost the 2004 election just because onion prices had skyrocketed. Interestingly, even Congress was not prepared for the 2004 win.

 

As an investor, I must maintain a neutral stand. I should be prepared for any outcome. I think if a stable government is formed that is expected by the market, we may not see a lot of market movement because a lot of that information is already captured in the recent bull run. However, if a stable government is not formed that will be against market expectations. This will lead to a short-term correction in the market. It would be silly for me to put a number to that correction. However, a smart investor will be prepared for any such correction. Business profitability and growth will drive valuation as it always does.  

 

Dr Kalam in his book, Ignited Minds talks about dreams, thoughts, and action. Dr Kalam also talks about developing a belief system. If we want to see our nation in the top league of nations in the world, we must also do our best and have the right belief system. A mere stable government will achieve nothing. Post Indira Gandhi’s assassination, Rajiv Gandhi came with an overwhelming majority but within a few years, India witnessed the most embarrassing moment. The world had no confidence in India’s debt repayment capability. IMF lifted gold from RBI facility. In fact, in the late 80’s, Pakistan was a much stronger country than India. In just three decades, India has achieved tremendous growth.

 

I hope we see a majority government at the centre and also see a solid opposition so that ‘We The People’ of India can benefit from being the largest democracy in the world.

bottom of page