The Mutual Fund Show: How To Build A Long-Term Portfolio

Shalini Sekhri: Yes, absolutely. We are at a time where every day is a new historic high and I think we are speaking on that very special day as we were just discussing before this call started. We would all love to be long-term investors. Every client we speak to says they do want to be long-term investors.

But I would actually like to start by asking myself and everyone on this panel whether we think it is possible to buy and forget your investments for 10 years and I think that's where really perhaps the views of both of us will come in today.

Now while I do believe that every investor will have a different asset allocation and depending on each lifestyle, current financial health goals, risk appetite, it would be very simple for an advisor to say that okay, for a conservative investor, let's do a 30% equity, 60% debt, 10% in gold, fill it, shut it and forget it, or maybe just keep adding passively to SIP. But similarly, for an aggressive investor that should do 70% equity, 25% fixed Income, 5% in Gold. Let's forget about it.

Honestly, unfortunately, I think the answer is more complex and individualistic than that and I believe we really have no choice but to take a goal-based approach, not just one that is goal-based but which requires a regular review and I think that's where really you know, structured financial planning comes in, discipline comes in, looking at your portfolio and your goals come in on a regular basis.

Honestly, if the plan is right, then the yardstick to measure the success, I believe is not whether the investment outperformed its benchmark, but rather how well it is able to help the investor meet their personal goals and that to my mind is truly a successful investment plan. That unfortunately requires some discipline and some work.

Himanshu Kohli: So, I would agree with Shalini about what she mentioned, the discipline. There are four things which impact the success of any investor, what should be my strategic asset allocation, market timing, product selection, and luck. These are the four things which impact the success of any investor as per various studies which have happened, empirical data on developed markets.

91% success comes if your strategic asset allocation is correct, market timing, product selection, luck contribute less than 10% towards the success of an investor. Unfortunate part is most of the investors in India and globally, they just keep on spending their energies and time on when to enter, when to exit, which product to buy and hope luck to support them and they forget the big picture on what their strategic asset allocation should be.

So, what happens through strategic asset allocation is the point which Shalini was mentioning. It brings in a huge amount of discipline and that is something where experts like us come into picture because people just talk about returns, but there's other part, which is the risk part of it and most important, the correlation or behaviour of one asset class versus the other asset class, one index versus the other index, one market versus the other markets. So that is something which is we believe, there is a lot of science which goes behind construction of the portfolio, basis the profile.

Let's say a median-age profile 35-40 years, if they have a really let's say 85-90 years of lifespan, if they just preserve and grow at 7%, Rs 1 crore can be Rs 30 crore, if they compounded at 7% which is conservative. But if they get into a moderate profile, which is combination of different classes, same period, 50 years, 35 year old invests with a 50-year kind of a time horizon it can be Rs 300 crore, and if they get into very aggressive mode, which is getting into businesses, unlisted businesses, it compounds to 16-17% it would be Rs 3000 crore.

But what determines whether one should be conservative, moderate or aggressive. It's actually the financial plan which needs to be drawn up, what is the need-based wealth, what is the surplus wealth which is for the next generation. So, this is what we get into and come up with a plan over there.

Himanshu Kohli: So, let's say there is a moderate profile of the investor. Moderate profile could focus on maybe 60% growth, 40% preservation or 70% growth, 30% preservation if its moderate plus, now base is that one can then get into a combination of not only debt and equity, but certain other asset classes also.

So, let's say debt alternatives could be another, equity alternative could be another one. Hybrid could be another one, gold could be the other one. So, basis combining these asset classes, basis the profile, one can actually create a portfolio. So, there could be two approaches. One is I will just get into balanced funds with the 7-year view, and I get maybe double-digit, low double-digit returns from my portfolio, but there could be volatility in between.

But other better approach would be where I see the correlation between one asset class and other asset class, maybe bringing in 20% gold, maybe bringing in 20% fixed income, maybe bringing in 40% equities, and maybe bringing 20% towards alternate asset classes. That can also give me a double-digit return with far lower volatility. So, investors could look at combinations like this or someone who is getting into a regular savings, systematic investment plan into mutual funds, depending on the risk profile.

So, equity could be one which is a preferred choice, but if someone doesn't want volatility, too much volatility which bothers them, and maybe we can get into a combination of equity plus BAF kind of strategies, balanced advantage funds, and systematically build the portfolio.

Himanshu Kohli: If it is systematic, I am very comfortable building it through systematic investments into equity mutual funds, but if it's lump sum investments, then I would like to have a portfolio allocation approach which is what I mentioned, combination of equities, combination of hybrid, combination of fixed income, debt alternatives, equity alternatives, that is how I would like to build up, maybe 10% of gold also on top of it.

Shalini Sekhri: So, from the outset I just like to highlight that if you look at the last 10-11 years of our various asset class return profiles, every year has thrown up a different top performer. 2022 which was not sure of excitement by any standard. I am sure a lot of viewers would be very surprised to hear that gold, which we just think of as the safe hedge part of the portfolio was actually the best performing asset class with a 14% return and equity just gave 4%, fixed income gave you 3%.

So, regarding your question on whether one should build a completely equity portfolio, well obviously, in the long term, the numbers are very clear that it gives us good risk adjusted return. The fact remains is that I strongly believe that asset allocation will be very important, every bucket would be required, because there's just absolutely no telling Russian roulette, as we seem to see in our markets, which asset class will be at the top of the heap.

So, I do believe that mutual funds do have a very wide spectrum of strategies. It will easily enable a client to be able to build out a well-diversified portfolio in line with wanting to be a long-term investor and also reaching his life goals and you can see that you have mutual funds across different asset classes or equity, debt, hybrid can match your investment goal by doing a growth or income or a tax saving fund or a fixed maturity fund.

You can look at a style right, so now there's a huge discussion on that we look at active mutual funds versus passive. On the active side, what I would like to point out is that, as from my analysis, almost 90% of large cap mutual fund managers have underperformed their benchmark on a one, three, and five-year perspective. What that means is perhaps at least to the large cap equity fund category, there is a very strong case to look at perhaps passive funds, which are the index and the ETF equity fund category.

So if I were to just quickly jump ahead what do I think we can advise the investor like the type that you suggested, a moderate investor looking for a steady kind of a portfolio with risk minimised, I would say that a client like this should look at say debt at about 40%, equity maybe 30%, balanced and hybrid which gives you a combination of equity and debt about 20% and maybe gold at around 10%.

Within equity itself, one can think of, maybe large cap index funds, as opposed to active funds at maybe 30%, multi-cap funds around 40-50% and the rest in mid and small cap. I believe this would dull volatility and would still deliver good inflation beating returns to an investor keeping their blood pressure low and enabling them to see some return in their portfolio year on year. So that's really my perspective.

Shalini Sekhri: So, I would think that to some extent, is completely leaving it to the fund manager in a way that it might not exactly match what should be your asset allocation. We are also seeing a situation where in order to make it tax efficient, we are seeing a fairly large percentage that's going into equity to be able to give up the equity taxation benefit. As a result, perhaps the percentage for something like gold, which might merit a larger allocation for certain kinds of investors, could be quite small.

So, our view is that in the year, let's say for example, 2022, gold is setting it out of the park, does it make sense to kind of be constrained by some of these, so while I do know, there are one or two fund managers where the constraints are not that much, I would say in general as a category, I believe that even with a little bit of help and advice and even one's own research, a client will be able to create a more suitable, tailored asset allocation for themselves. That's what I would do if I was an investor. 

Himanshu Kohli: So, I could say someone who doesn't have the luxury of appointing a wealth manager or hiring a wealth manager, multi asset fund actually works out very well for them and the reason is, sometimes we do not get the time to look at the portfolio, sometimes there's inertia, sometimes it is a cost angle which comes into picture whether it is taxation, whether it is entry or exit loans, all those things.

So multi-asset actually works out fairly well and also if you see hybrid funds, which have just followed maybe two-third equities and one-third fixed income, historically, they have not only reduced the standard deviation, but they have also created half to 1% alpha, compared to a static portfolio of two-third equities and one-third debt.

So, I would say someone who cannot rebalance, someone who does not have the luxury can actually look at a multi-asset portfolios, someone who has, they then can actively manage it along with the wealth manager and look at those options.

Shalini Sekhri: I absolutely agree with both Himanshu and you that for a long-term investor, what I was saying was that I believe that averaging out through SIP as Himanshu pointed out is a wonderful tool to take advantage of the ups and downs of the market.

The other real risk mitigant you know, if risk can have a mitigant, then why not. I think one can certainly look at equity and I think the best just mitigant this time and with enough analysis all around to show that in general if you look at a five-year holding period, there are almost no periods where a client who's had a five-year horizon has actually walked away with negative returns from equity.

So, I would say risks, if it can be mitigated by staying invested for longer periods, is certainly a great way to go and enjoy the returns that do come with equity as an asset class.

Himanshu Kohli: So, it's very important to follow our core and satellite approach while you are also selecting your mutual fund portfolio. So, let's take a simple equity asset class, 20% large caps, 40% multi caps, 30% mid and small caps, and 10% could be a sectoral fund, or a contrarian fund which could come into the picture.

I have seen sometimes a sectoral fund because the fund manager has to pick up 30-40 stocks because of diversification. Even if there are eight to 10 stocks which are very good, the balance 30 comes more like baggage over there and the risk-return matrix doesn't justify.

So maybe taking a 10% kind of a contrarian view, which could be heavy on a healthcare side would be a good approach because last three years if you see, benchmark index has compounded by 25% while healthcare index has compounded by 16.5% but if the averages have to hold good.

Maybe healthcare will also do catch up in the next three or four years and if someone is entering with that kind of a time horizon, it makes sense to be slightly overweight compared to what the index of healthcare is. So, there I would say maybe getting into a contrarian fund which has reasonably higher exposure can be a good option.

But if one doesn't want to rely too much mind on this, maybe then taking up a simple healthcare fund like SBI is fairly stable and seasoned, has given one of the best highest returns per unit of risk over a period of time, could be looked at as a fund within healthcare.

So, I would not recommend going for a pure sectoral fund because of the challenges which I mentioned over there. But if someone still wants to get over there better is to go through a contrarian strategy. If not, then maybe just selecting one of the most stable options only to a smaller extent, which is a satellite, not the core portfolio of theirs. 

Shalini Sekhri: Right, so I think there's no arguing that with Covid-19 that's been a sector that's front and forward. The last few weeks have been flooded with news flows such as you know, large insurance companies are buying healthcare stocks, foreigners are buying a lot of healthcare stocks in India and as a result clearly, we are seeing some tailwinds here.

I was looking at the one-year, three-year returns of some of the best performing funds, all are a stellar, 20% plus even on a one-year basis, if I look at the top quartile. You would still be surprised to know that this by no means is one of the best performing sectoral funds or sectors. So, there are many more which have done far better than this.

So, I think therein lies the rub that in India where you see so much sector rotation every year, that every year is throwing up very different winners and losers and the divergence between the worst performing and the best performing sectoral funds is huge.

It's quite hard, I would think, for a layperson to be able to take the relevant call. That having been said, I think intuitively we all understand that healthcare, which today is not just pharma, but a lot more sectors such as hospitals, etc. certainly has, you know, structural tailwinds.

I think one will make decent returns there and you could look at a small allocation and as Himanshu said, there is the SBI one or perhaps you know, DSP has a good stable portfolio, Mirae Asset Healthcare. So, there are these three or four larger stable funds which are doing well, but again, to point out these are certainly not the best performing sector funds when I throw in all the other sectoral funds other than healthcare as well, that exists today.