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A Perfect Portfolio

Invest regularly with a plan and follow a few guiding principles for the

I have been a mutual fund investor since 2006 and have tried to use the Value Research fund classification system to build my portfolio. My investments are for the long term and I do not require the money as of now. The returns from the mutual fund investments are around 34 per cent. I want to know the best way to make a portfolio based on the Value Research classification. Since I do not need the money, should I remain invested in these funds or book the profits? If I book the profits, I again will be investing it in mutual fund using SIP. Does it make sense?
Deep Rastogi

It is heartening to note that you have built your portfolio based on our fund classification. The basis of the Value Research fund classification is to group funds with similar traits. The classification helps in bringing homogeneity among funds within a category allowing logical comparison amongst peers and categories. So, traits of a large-cap fund and that of a mid- and small-cap fund are clearly distinguished, though both are equity diversified funds. The fund classification, which was recently updated brings in more objectivity when understanding what each category of funds hope to achieve.

Building a portfolio based on the Value Research classification is a good starting step. The risk-return reward for each category varies and having an understanding of the same will help you allocate your investments into different categories. You can then use the Value Research star rating to select the relatively better funds within the category. The star rating is based on risk-adjusted rating system and acts as the first filter in fund selection. A higher rating indicates good performance and one should ideally look for funds that have consistently carried high ratings.

Portfolio characteristics
These are a series of statistics that provide information about a fund in relation to its benchmark index. It also details the type of securities held by the fund, its performance over different time frames. These statistics help explain the performance of a fund in both absolute terms and relative to its benchmark. There is also the fund style box that depicts the portfolio’s investment style, whether growth or value, based on the combined portfolio attribute of all the funds. So, it is possible that you may have selected funds with value as the goal, but the combined impact may have a growth tilt. The market-cap classification indicates large-, mid- and small-cap weightage and the valuation indicates the portfolio to be growth, value or blend.

Guiding principles
Building a mutual fund portfolio is not an easy task. It is our belief that a direction is what investors should have to make use of the principles and invest on their own using the tools available on our website and magazines to manage their investments. Selecting a good fund is not hard if you can reverse the thought processes followed by most retail investors. Most investors hunt for high returns first and some stop right there, inviting absolute disaster. Others go on to glance at risk, then make a cursory check of the expenses and finally think about how a fund fits in with the rest of their investment plans.
By reversing that order, you can vastly improve the odds of finding the right fund. First, see what funds fit with your overall investment plan. The next-to-last thing most people do — but the second thing you should do — is to check on expenses. Returns fluctuate but expenses stay forever. Finally, look at risk. Even though funds issue a statutory warning that past performance is no guarantee to future performance many disregard it. What goes up can come down just as rapidly. Ask yourself if you are prepared to stomach the losses if your fund’s performance goes down. If the answer is “no”, look for another, less risky fund.
While you have indicated the allocation you have across different categories of funds, we are not sure on the number of funds that you have. While diversification helps, it works best when done intelligently. Diversification depends on the kind of funds you own, not on how many you own. If you do not need the money and plan to invest the money back into funds; you may be better of staying invested in the funds that you have.

Investment checklist
• Set a financial goal or an investing plan before you buy a fund
• Assess your risk tolerance and match it with the fund’s profile
• Track your investment periodically and make suitable changes by rebalancing your portfolio
• Don’t let short-term volatility guide your decision

Follow up
Investing in equity mutual funds is dynamic. Stock prices change every day and so does its impact on your fund’s performance. A fund that is good today, need not be so tomorrow. Likewise, the need for a category ends once the objective with which investments in it were done are achieved. To some readers, a lot of what we have said may appear a little time-consuming. However, once imbibed, it will become second habit to evaluate funds, build a portfolio and track its performance using the portfolio feature on our website, making investing a pleasure. Tracking is very important and it should be done at least once a year to check the portfolio performance and make any changes if need be.

A portfolio is built to achieve financial goal(s)
Risk and Return
At the cornerstone of any savings or investment plan is the relationship between risk and return. As a rule, the potential return on any investment generally corresponds to its level of risk. When creating a portfolio, it is imperative to understand the risk quotient of each type of fund and then invest in it accordingly.
But, the bigger objective of a portfolio centres on the principle of diversification. This is achieved with different categories of funds in a portfolio that helps in building the core and satellite components of the portfolio. Diversification follows the basic logic of not putting all your eggs in one basket. As different securities perform differently at any point in time, with a mix of asset types, the portfolio is cushioned and does not suffer the impact of a decline of any one particular security. For instance, when mid-caps run out of favour, large-caps cushion the swing.
Risk-Return Hierarchy
The risk-return gradient from the least risky equity diversified category to the most risky category is as follows
Least risky category: Hybrid-Equity-oriented
Funds with greater than 60 per cent equity exposure over the last one year such as HDFC Prudence and Reliance Regular Savings Balanced
Large-cap category
Funds with more than 80 per cent assets in large-cap companies over the last three years such as Franklin India Bluechip or IDFC Imperial Equity Plan A
Large- and Mid-cap category
Funds with 60 to 80 per cent assets in large-cap companies over the last three years such as HDFC Top 200 or Birla Sun Life Frontline Equity Plan A
Multicap category
Funds with 40 to 60 per cent assets in large-cap companies over the last three years such as Quantum Long Term Equity or ICICI Prudential Dynamic
Most risky category: Mid- and Small-Cap
Funds with at least 60 per cent assets in small and mid-cap companies over the last three years such as DSPBR Micro Cap and HDFC Mid-cap Opportunities

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