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Portfolio Makeover

Diversification is crucial. But too many funds may create manageability problem

Problem of Plenty
My investment worth Rs 1.33 lakh is spread over 18 mutual funds, including seven tax-planning funds. Please review my portfolio and suggest ways to derive maximum benefit out of it. I am 42 years old and willing to stay invested for the long-term.
-Amit Bhattacharya

Value Research Portfolio Manager suggests 90 per cent of your asset is in equities, 3 per cent in debt and the rest in cash. Large-cap stocks dominate your portfolio with an allocation of 52 per cent, while mid- and small-cap stocks constitute around 45 per cent of the equity assets. You have invested in three new funds, rest of your funds enjoy at least a three star rating from Value Research.

Bhattacharya's Portfolio
Funds  % Allocation
Part I  
Birla Sun Life Basic Industries 3.76
Franklin India Bluechip 7.52
Franklin India Flexi Cap 5.26
Franklin India Prima Plus 7.52
Franklin India Prima 10.51
HDFC Capital Builder 10.51
HDFC Equity 9.01
HDFC Prudence 5.26
Reliance Equity 3.76
Reliance Growth 7.52
Reliance Vision 9.01
Sub-Total  79.64
Part II  
Birla Equity Plan 0.75
Franklin India Taxshield 4.52
HDFC LT Advantage Fund 3.76
HDFC Taxsaver 3.76
Reliance Tax Saver 2.25
Templeton India Pension Plan 3.08
UTI Equity Tax Savings Plan 2.25
Sub-Total  20.37
Total  100

At stock and sector levels, you have achieved decent diversification. Having said that, we believe you have too much of it. Diversification is crucial. In fact, this is one of the prime reasons why small investors are suggested to buy funds. But do not take it too far. Too many funds may create manageability problem. It won't be easy to figure out which fund is pushing your returns and which one is taking it down. Moreover, a large number of funds may result in an out-of-focus portfolio that will resemble an index fund and you will end up with average returns but with much higher cost. All we want to say is that it's possible to achieve good results with few funds, definitely much less than 18 funds that you hold at present.

Now, let's see how we can trim your portfolio to make it more focussed. While doing so, we will not add any fund but reallocate the asset to your existing funds only. Your portfolio primarily has three types of funds - equity funds, tax-planning funds and hybrid funds. Templeton India Pension Plan is a debt-oriented fund that offers tax benefit as well. Since you are ready to stay invested for a long time, we would, therefore, like to suggest you an all-equity portfolio to start with. Having said that let us clarify that HDFC Prudence is a star performer and suites any portfolio. If you have strong liking for this fund, you can stay invested.

You have seven tax-planning funds, which come with lock-in of three years. Therefore, we would like to treat your investments as two separate portfolios (see Part I & Part II) - one for funds without any lock-in and the other for tax-planning funds. But before we move ahead, let's make it clear that your existing portfolio has quality funds and many of them could be retained easily. But since we are attempting to reduce the number of funds substantially, we need to take some tough decisions and choose the best of the lot.

Let's rework Part I first. You have 11 funds spread across four AMCs with three mid-cap funds. The other funds too invest in mid and small-cap stocks, pushing your overall exposure to the relatively riskier class higher.

Therefore, in your proposed portfolio, we have substantially cut exposure to mid-cap funds. Instead, the emphasis has been laid upon funds that have freedom to invest across market capitalisations. HDFC Equity, Franklin India Prima Plus and Reliance Vision offer versatile portfolios which shift swiftly with market conditions and therefore are well-suited to form the core of the portfolio. Franklin India Flexi-cap is a similar fund but we have preferred Prima Plus for its long-term performance record. Since Flexi-cap has performed well in its short existence of around a year and has the same management, you can opt for it as well.

Now, let's tackle Part II of your portfolio. You have seven tax-planning funds, including the debt-oriented Templeton India Pension Plan. Since these funds come with a lock-in of three years and you would have invested at different points of time, you can't rebalance this portfolio immediately. You will have to wait for the money to get unlocked.

Suggested Portfolio
Funds  % Allocation
Franklin India Prima Plus 15
Franklin India Taxshield 8
HDFC Capital Builder 10
HDFC Equity 25
HDFC Taxsaver 12
Reliance Growth 10
Reliance Vision 20
Total  100

As and when the money is available, you can consolidate this part of the portfolio into HDFC Taxsaver and Franklin India Taxshield. While the former offers a rare combination of low risk and high return, Franklin India Taxshield has a good long-term track record, quality portfolio and management depth. You will have to treat Templeton India Pension Plan differently because redemption before you attain the age of 58 years would amount to paying exit load. Therefore, you can let it remain in the portfolio. And as your goal nears, start tilting your all-equity portfolio in favour of debt funds.

Stay on Course
I am 65-year-old and have no liability. I have invested Rs 1.80 crore in 6.5 per cent RBI tax-free bond, 8 per cent RBI taxable bond and 5.5 per cent REC capital gain bond. My MF investment worth Rs 53.50 lakh is spread over 12 funds. I shall invest Rs 15 lakh in 2006. How should I go about it? These investments are for my wife and divorced daughter and I do not need to encash the same in my lifetime. However, I would like to have dividend income of Rs 3 lakh from the equity funds.
- JS Anand

Here's what the Value Research Portfolio Manager says about your mutual fund investments: 93.5 per cent of the portfolio is invested in equities and the rest in cash. High quality five- and four-star funds manage nearly 87.5 per cent of your assets.

Anand's Portfolio
Funds  % Allocation
Birla Dividend Yield Plus 3.93
Franklin India Bluechip 8.64
Franklin India Prima 14.12
HDFC Equity 10.77
HDFC LT Advantage Fund 3.36
HDFC Taxsaver 6.50
HSBC Equity 12.04
Magnum Contra 2.43
Pru ICICI Tax Plan 5.84
Reliance Growth 20.03
Reliance Vision 8.01
Tata Equity Opportunities 4.33
Total  100.00

Nearly half of your portfolio is committed to mid- and small-cap stocks, while large-cap stocks command 47 per cent share. At stock and sector levels, your portfolio is well diversified.

Conventional thinking would probably brand your equity exposure as too high for your age, but we think that since you have no short-term needs, this is fine.

However, within your equity exposure, you have a high allocation to relatively risky mid- and small-cap stocks. This allocation is likely to shoot up further given high concentration of your investments in funds biased towards mid-cap stocks. To illustrate, the top two of your holdings are both mid-cap funds. There is scope to bring that down. But given the long-term nature of your portfolio, managing this problem should not be a huge challenge. Going forward, keep a close eye on their share and rebalance from time to time.

Another way of managing their dominance could be investing your Rs 15 lakh of planned investment in large-caps-oriented funds. Of your existing funds, Franklin India Bluechip can be a good choice. Funds like HDFC Equity, HSBC Equity, Reliance Vision too maintain a good exposure to large-cap stocks. You can avoid Birla Dividend Yield Plus, which is a one-star fund.

Regarding dividends, we would like to make it clear that expecting regular dividends from equity funds may not be a wise idea.

They are not obliged to declare dividends in a defined time period and hence, are not dependable for regular income. But at the same time, your expectation is not unrealistic. We can restate your dividend objective in this manner: You basically want to take out Rs 3 lakh (which means 5.61 per cent of your portfolio value) every year without having to delve into your principal investment. So we can say that all you need to achieve your objective is that your investments rise by at least 5.61 per cent per year so that you can redeem that much while keeping your principal intact. And this looks to be quite a reasonable expectation.

See, dividend is nothing but your returns which is distributed by the fund house from time to time. And upon such distribution, a fund's net asset value (NAV) drops by the amount so distributed. But if the fund house does not declare dividend, you can 'create' dividend for yourself simply by selling a part of your investments.

The only difference is that in the first case, the NAV will drop while in the second case, the number of units will reduce. In either case, the total value of your investment will be the same.

Going forward, we don't feel you need to do anything significant expect for regular monitoring and occasional rebalancing. For further investments, opt for one of your existing large-cap oriented funds.