Diversification brings dynamism to mutual funds portfolio

Last year has been a rollercoaster ride for the investors particularly in the equity markets. The equity mutual funds (MF) have undergone re-rating of equities, re-introduction of long-term capital gains (LTCG), tax corporate shenanigans, macro-economic swings, geo-political disturbances and Sebi (Securities Exchange Board of India) categorisation, testing all the stakeholders from investors to fund managers to advisors alike.

There has been an erosion of value and this is strikingly evident in the mid and small cap funds. The large caps managed to eke-out a single digit gains while most other indices except Information Technology (IT) ended up in negative territory.

The year experienced huge whipsaw movements in the stock markets and was reflected in fund returns of portfolios leaving pain for the investors. Though, the domestic fund flows continued, investors’ confidence was at a low due to an increased volatility.

The foreign fund outflows continued unbated with the dollar strengthening and the US Federal Reserve’s sustained interest rate hike. These factors sowed doubt in the investor’s mind and also made them to re-look at their portfolios leading them to cast a doubt on their existing funds.

What should one do when an invested fund has started to lose money? The answer is not straightforward, though. One has to ascertain if the losses are in-line with the broader market or endemic to the fund.

The other important factor is to compare it with the index or benchmark the fund is tied to. With the current categorisation, it has become easier for the investors to compare this. Also, one has to understand if the losses are prolonged and so check for the corresponding period with the peer group.

First, one needs to also find out what’s the expectation of the investor when they were investing in a particular fund. The fund’s performance whether under or over could be established once the expectation is understood.

If it’s an expectation issue, then the investor is better off finding a fund with the suitable investment philosophy that matches their expectation. But if the fund is underperforming their peers and/or benchmark then it needs a serious consideration.

Secondly, it’s highly difficult to continuously generate higher returns especially during an overall distressed market. It means that a fund experiences phases of underperformance with regards to its benchmark and peers.

If these periods are sporadic and short term, then the investor is better off to ignore as long as the fund sticks to its mandate. In case of prolonged underperformance against the benchmark for period of upwards of a year then a reconsideration from the investor is required.

Third, switching between funds is riskier as it’s difficult to time the performance of a fund for a particular period and it also involves costs like capital gains and exit loads. One has to always remember that the performance is of past and is not a guarantee of future outcomes. One may not earn better returns simply by switching between funds.

Fourth, timing the market is not easy if not impossible. It’s difficult to time the market consistently and hence time spent in the market is essential. If a fund’s strategy is accurate but the market conditions aren’t ripe, investors could take advantage of the periods of underperformance by infusing or averaging the fund thus benefiting as the tide reverses.

Lastly, an investor could check the consistency of the fund from time-to-time. If the fund is not a top-performer always but manages to remain in the top quartile in comparison with its peer group, then the investor could be in a spot of comfort.

Of course, if there’s a deviation and the underperformance is huge and sustained then investor could look for better pastures. Overall, if the fund was an outperformer but remains underperforming for a longer term one should have a critical look at it.

Moreover, a good diversification and a creation of portfolio would not only contain the risks and underperformance but also provide variety and bring dynamism to the overall investment experience. (The author is a co-founder of “Wealocity”, a wealth management firm and could be reached at [email protected])