Art of creating a mutual fund portfolio

While investing for a financial plan or otherwise, for investors, a mutual fund (MF) portfolio assists in providing a great way of diversification, asset allocation and creates a good foundation. MFs are an easy and convenient way building a portfolio which is professionally managed, high on liquidity and actively adjusted to the market scenario. But the broad spectrum of MF is huge and enormous. However, one needs to understand a little bit about the various categories and how it suits the plan; to ensure a robust portfolio is build benefiting the investors' interests.

Investing, otherwise, boils down to the investor's requirements and risk appetite. Risk can't be avoided but could be mitigated with appropriate asset allocation and diversification methods. The timelines of the goals or the investor's requirement, hence, plays an important role in ironing out the risk to an extent. We'll dwell this part in detail further. MF offers broad range of solutions that allows investors to explore and expose to equity, debt, commodities (gold/silver, etc.) and even to some alternate investment options like REITs (Real Estate Investment Trust), InvITs (Infrastructure Investment Trust), etc.

Of course, the first and foremost an investor should do is to draw a timeline for the investments. This helps in coming up with suitable allocations to various asset classes. Bear in mind, that the short-term needs should be always directed to debt exposures. Within debt, the sub-category allocations would be discussed in a short while. So, for a need less than three years' time, an exposure to equity could be limited or even zero. The allocation to equity could be increased as the timelines extend medium to long-term stretching into 10-15 years and beyond.

The short-term market gyrations are part of the nature of equity investment and history suggests that the volatility is reduced as the time spent in the market is increased. Time spent in the market always trumps timing the market in the long run. This allows investors to pursue allocations of over 80 per cent in equity for the longer horizons. One could also opt for a systematic investment or staggered allocation to wriggle out the short-term capricious nature of the market. The rest could be explored through debt or precious commodities to enjoy the fruits of diversification.

The choice of funds within the equity could again be considered based on the timelines though the risk profile of an investor provides a peek. For investors with moderate risk could explore 30-40 per cent in large caps with an equal proportion to flexi/multi-cap funds while the mid-cap-oriented funds could occupy the rest of the allocation. For an investor with a risk profile tad higher between moderate and high risk; could add 15 per cent to small cap funds, 20-25 per cent to mid-cap funds and the rest could be exposed to multi/flexi-cap and large cap funds. Investors with a much aggressive profile could consider a 20 per cent allocation each to International, small and mid-cap categories while the rest could be spread in flexi/multi-cap.

Nevertheless, investors must remember taking higher risk doesn't always directly proportionate to a higher return. Coming to the debt allocations, one could be comfortable allocating to overnight or liquid funds if the time frame is 1 month or lower. The choice improves with as the horizon goes to around three months through ultra-short to low duration funds. Floating rate funds could add as an anti-dote in a rising interest rate scenario, but the investor should be ready to brace the short-term volatility and so would suggest at 3 to 6-month timeline. Investors looking for two years and above could consider short-term funds or even banking PSU funds where the latter have a relatively lower risk profile. These categories of funds are subjected to interest rate or inflation risk.

Serious investors in debt should consider investments with horizon of three years and above as it provides better tax arbitrage. Medium-term and corporate bond funds fall in this category with credit risk being one of the major criteria and suitable with moderate risk appetite. For those with higher risk profile, could explore gilts and credit risk funds which have a higher volatility of interest rate and credit risk respectively. Investors with 5-years and beyond could expose part of their investments to these funds. Dynamic bond funds would form as intermediary between the moderate and aggressive risk-taking investors as the securities allocated in these have a varying mix of medium and long-term bonds.

From a debt perspective, a portfolio with a moderate liquidity and with a 3-year horizon could consider an allocation of a fifth to liquid funds, about a same portion to ultra-short term, while the rest could be distributed among the short term and corporate bond funds. A 3-5 year moderate portfolio could encompass one-tenth to ultra-short and floating rate funds each, about a third to short term and bond funds, another third to medium duration funds while the rest could be allocated to credit risk funds. For a long-term investor of 5yr and over, 10 per cent each for ultra and floating rate funds, a third each in medium term funds and dynamic bond funds, and about 20 per cent in credit risk and gilts.

Hybrid funds are another category that could well be placed in most portfolios which offer best of both the worlds i.e., equity and debt. Some of these funds also come with a small exposure to gold as an allocation and even derivatives hedge. These funds could also be used as risk moderating tactic in the overall portfolio. An annual review of the MF portfolio for rebalancing could help keep it in tandem with the market dynamics.

(The author is a co-founder of 'Wealocity', a wealth management firm and could be reached at [email protected])