In a recent webinar with Morningstar, Nirav Karkera, head of research at Fisdom, spoke about the basic tenets of building a sound portfolio through mutual funds. Here are some interesting takeaways from this conversation.
How many funds should investors ideally hold in a portfolio?
There is no fixed set of ‘ideal number of funds’ an investor can hold in her portfolio. It depends on the investment objective and risk appetite of the investor. Every fund has a role in the portfolio. If your portfolio needs a certain allocation to a certain asset class within a certain market cap and a sector, one can decide on a fund that suits the objective. Invest in only one such fund.
You will not achieve diversification by investing in five Large Cap Funds, which invest in the 100 largest companies. Hold one fund each in Large, Mid and Small Cap category. Within the same theme/market cap, you need not have more than two funds as a thumb rule. You will do extremely well with one fund. If the need arises, stretch it to two but not beyond that. I don’t think a combination of three funds within the same category or market cap will much more benefit except when it is a thematic fund or sector fund.
Should you invest in the top-performing fund?
It is a hindsight bias, which is a general human tendency. It is not correct to look at the past performance and decide the future trajectory by looking at performance in isolation.
Just because a fund has done well, there is no surety that it will continue to do well. Similarly, if a fund has performed badly in the recent past, it does not mean it will continue to underperform. Many investors would know this principle well. But still, we have a tendency to extrapolate past performance into the future. Performance must be viewed in context. You must see the broader market performance, economic situation, and the fund’s positioning and change the context in the current situation to see whether the same performance can be sustained in the current context.
One should look at risk-adjusted-performance. It is an underappreciated concept. Everyone knows about it and talks about it but no one is looking at it. So don’t chase performance at the cost of risk.
A fund is a by-product of the underlying securities and fund objective. Many people take this a notch ahead. They tend to invest in funds that have performed badly in the recent past, thinking that the performance will turn around. they think if some fund is underperforming now, it will perform well in the future. Bottom fishing is never a good strategy, neither in stocks nor in mutual funds. don’t decide to invest just because the fund is top-performing. In the same way, don’t invest in funds that are bottom-performing. Take a little effort to understand the performance in context. If you can’t do it then outsource it and hire an adviser.
What are the four filters one should apply while picking a fund?
1. Look at risk-adjusted return. This may not be available everywhere so view the risk metrics such as Standard Deviation, Beta, Sharpe ratio, Sortino Ratio, etc.
2. Look at fund management pedigree and expertise. How long a fund manager has been managing that strategy, the team. What kind of experience a fund manager has across different funds and how it will help this fund.
3. Check the sectoral exposure of a fund to see if a fund has overconcentration in a sector vis-à-vis category. Such an aggressive strategy can backfire.
4. Look at the market cap allocation. This helps to check if your investment objective and risk profile fit with the fund’s strategy.
There have been a slew of new fund offers in 2021. Should investors consider investing through NFOs?
One should not look at NFOs as a category. It is just a fund with a unique idea and methodology. It is trying to achieve a certain objective. It should be looked at as a by-product of its underlying securities. Investors should not have a blanket approach towards NFOs because each NFO is different. You can’t decide if an NFO is good or bad because each one is different.
Unlike IPO where your objective is to get it a lower price based on its long-term potential; I don’t feel there should be any FOMO when it comes to NFOs. They invest in stocks that are already listed. Unlike IPO subscription prices, the NAV does not reflect the fact that you are getting the underlying shares at a cheaper rate. The NAV is a derivative of shares that are trading at their respective valuations.
There is no need to rush into buying during the NFO period, especially without seeing its underlying portfolio you can see the portfolio in 15 days post-NFO. Every great fund was an NFO at one point in time. AMC’s job is to manufacture new funds and give investors access to new ideas and themes. You are not missing the bus by not investing during the NFO period.
If a fund does not have a track record it does not mean that the underlying securities do not have a track record. The fund is new but the stocks are old. The fund managers have a history. See how the fund manager of an NFO has performed in the past.
