Mutual funds can make for excellent asset allocation tools. Read on to find out how you can use them while constructing your portfolio.
I was recently watching a television show wherein an investment expert was taking queries from callers who dialed-into the show. The expert was making a rather strong case for asset allocation and exhorting callers to invest in diverse assets classes.
His constant rhetoric was: “diversify your portfolio by investing in various asset classes such as equity, fixed income, gold and mutual funds”. That line got me thinking. Here was an investment expert who believed that mutual funds are an asset class by themselves much like equity or gold!
In reality, mutual funds are investment avenues that can help you invest in a variety of asset classes, rather than a distinct asset class. For instance, if you wish to invest in equity, then you can select a large-cap fund or a small/mid-cap fund.
Likewise, a bond fund or a government bond fund can help you take exposure to the fixed income asset class. Hence, it is important that mutual funds be seen as a “means to an end” rather than an “end” itself.
Mutual funds are multifaceted avenues given the choices they offer. To better understand this, let’s take the case of an investor in his 20’s whose investment objective is long-term wealth-creation.
His portfolio can be constructed as follows: 40 percent in large-cap mutual funds forming the core of the portfolio, 25 percent in small/mid-cap funds, 5 percent in sector funds to provide an impetus to the portfolio, 15 percent in short-term bond and gilt funds for fixed income exposure, 5 percent in money market funds to keep the portfolio liquid and to allocate a portion to gold, 10 percent in gold funds.
This example demonstrates how one can build a robust and diversified portfolio that has exposure to multiple asset classes despite being invested only in mutual funds.
It is noteworthy that some mutual funds are inherently tools of asset allocation. For instance allocation funds such as balanced funds and monthly income plans simultaneously invest in equity and fixed income instruments in different proportions.
Fund companies have smartly tapped into the Indian investor’s long-standing fascination for gold by introducing funds that can simultaneously invest in equity, fixed income and gold (via the ETF route).
The portfolio manager decides the allocation to be made to each asset class within the broader limits mentioned in the Scheme Information Document. In effect, such funds are a one-stop-shop for asset allocation.
Let us also not overlook the significance of portfolio managers who are responsible for running funds. Managers are seasoned investment professionals who understand the nitty-gritties of the asset class they operate in, and are better equipped to deliver versus retail investors investing on their own.
So what should you as an investor do? For you, the key lies in determining the right asset allocation mix i.e. which asset classes you should be invested in and in what ratio, and then selecting the right funds.
It would help to engage the services of an investment advisor or a financial planner. Clearly mutual funds can make for excellent asset allocation tools and you would do well to exhaustively use them while constructing your portfolio.
The author is a Senior Research Analyst with Morningstar.
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