VR Logo

Investors in an Ethical Dilemma

Managing ethically correct investments is not easy, but there are options worth considering

I am a first-time investor and have been investing a portion of my savings in six different mutual funds over the past ten months and have a high concentration, of over 90 per cent in equity. I cannot invest my money in debt funds for religious considerations. I understand such type of investing involves very high risk. I would like to know if I also need to rebalance my portfolio from time to time. I have an investment horizon of 7-10 years. Funds that I have been investing in are Tata Ethical, SBI IT, SBI Pharma, L&T Global Real Assets, ING Global Real Estate & ICICI Prudential Exports and Other Services. Please guide.
- Osama

You are quite right to fear that your present portfolio carries quite a bit of risk. The returns that you make from this portfolio can swing quite a lot from year to year. Your current portfolio is well diversified with 95 per cent equity exposure across 68 stocks. The risk to your portfolio is most on count of it being made up almost entirely of sector funds.

Concentrating investments in one sector may pay off quite well in the short-term if the sector is favoured by markets, but it can be quite damaging to wealth over longer holding periods of 5 or 10 years, as individual sectors can witness a downturn in fortunes or fall out of favour in the stock market. When investing in sector funds, you need to buy as well as sell your funds at frequent intervals to take advantage of sector cycles, which you, as a first-time investor may find difficult to manage.

The call to move across sectors, in case of investments in diversified equity funds is taken by the fund manager, thus protecting your investments from wild swings. Moreover, systematic investment plans, which you seem to be using, also work best with diversified equity funds rather than sector funds.

Gainful year
The funds in your portfolio have fared quite well in the last one year (See: Current Portfolio). We find that ICICI Prudential Exports and Other Services has been an out performer and so have been SBI Pharma, SBI IT and Tata Ethical Fund. These funds have beaten the Sensex by 18.8 per cent in this period. Despite ING Global Real Estate and L&T Global Real Assets (1-year return of 7.2 and 15.2 per cent) lagging Indian stock markets, the average portfolio returns on your funds have remained ahead of the markets. The sector funds you own have outperformed for different reasons and these factors may not support them over the long term.

India's macro fundamentals are looking up in recent times (improving current account deficit, better business confidence, rising FII flows), the rupee has strengthened significantly from its lows of September 2013. Should the economic recovery gather steam post elections, and FII flows continue, the rupee may hold steady. This may make it harder for IT, export and pharma funds to outperform strongly from here on. The same logic holds good for global funds too, which rely partly on rupee depreciation for their returns. This reversal is already evident from the slipping returns on these funds in the last one month or so.

Ethics at play
You have built your current portfolio around sector funds mainly because you would like to be compliant with Shariah laws. While this is commendable, do note that such investment restrictions could lead to missed opportunities for you on earning higher returns or lowering the risk on your portfolio. Shariah compliance would require you to avoid companies with high debt, those which earn profits mainly from interest receipts (banks and finance companies), as well as businesses that are prohibited by Islamic laws. While avoiding companies engaged in non-Halal activity is not difficult in the Indian context, staying away from leveraged companies and lenders is quite difficult as banking and financial stocks make up a fourth of the market.

It is inadvisable to have a fully equity oriented portfolio, even early in your career. We suggest that you examine the following investments, and obtain independent views on their Shariah compliance-Dividend yield funds, which earn their income from profit shares instead of interest, debt instruments such as NCDs and deep discount bonds that accumulate your returns as capital gains instead of paying out interest, cumulative fixed deposit schemes from companies other than NBFCs or banks.