May 10, 2014,16.21 IST
Looking to invest in equity funds? Help is at hand
The stock market has been doing well for some time now. Going forward, a stable government at the centre and its focus on key economic measures could emerge as a key catalyst for the market. Although retail investors have been conspicuous by their absence in the stock market, they would take the plunge at some stage.
If you are one of those investors who may like to begin investing in equity funds now, the key would be to start the process by deciding your asset allocation rather investing randomly to benefit from the momentum in the market. The key factors that should play an important role in deciding your asset allocation are time horizon, investment goals and risk profile. This process will help you in deciding how much money has to be invested for short term, medium term and the long-term.
Remember, when you invest long-term money into equity funds in a disciplined manner, the current market levels and the volatility that you may have to encounter from time to time should not be a cause for any worry. A combination of having a definite time horizon and regular investments will help you in turning volatility to your advantage through averaging over time. Of course, you need to be careful in terms of selection of funds.
Investors often get attracted to short term performance of funds and end up investing aggressively in some of the top performing funds. The strategy of chasing short term performance exposes them to higher risk. Although past performance is an important aspect of the selection process, it's important to rely on consistency in the performance over the long-term. Besides, you must analyze the performance of selected funds vis-à-vis their benchmarks and the peer group. This will eliminate funds that may be having an impressive short term performance but lack consistency over longer time periods from your selection process. Another important factor that needs to be considered is the risk taken by the fund to deliver those returns.
All of us expect every fund in the portfolio to do well at all times. In reality, however, the performance of different funds varies from to time. Therefore, it is always good to know what to expect in terms of returns from funds following different investment philosophies. This will prepare you to logically handle the situation wherein some of the funds in your portfolio may lag others in terms of performance. Remember, a drop in the performance of some of the funds may not always be non-performance.
For example, in the on-going stock market rally, large cap stocks have under-performed their mid and small cap counterparts and that shows in the comparative performance. At some stage, money will move out of these well performing segments thus reversing the trend in the performance. In any case, large cap funds have to the core of your portfolio as they bring in stability to it. However, if the performance of a large cap fund lags its peer group consistently for a few quarters, it should be a warning signal. Similarly, sector funds in the portfolio may behave differently from broadly diversified funds due to their narrow focus. As is evident, it is important to know the risk and reward matrix for different categories of funds before investing in them.
Then, there is an issue of choosing between a fund that has a well diversified portfolio and the one that has a concentrated portfolio. While a well diversified fund will allow you to spread your investments across a large number of stocks in different sectors and segments of the market, a fund that has concentrated holdings works exactly in the opposite manner. As the name suggests, it concentrates on fewer stocks thereby having higher exposure to individual stocks. Although funds that have concentrated holdings can be riskier than well diversified ones, a well defined investment strategy and quality portfolio of stocks spread across different sectors can allow the fund manger to perform better than diversified funds.
Therefore, the portfolio should have a combination of both these types of funds. The key would be to have them in the right proportion. Broadly speaking, by investing around 10-15 percent of your equity investments in funds that have a concentrated portfolio, you can enhance your overall portfolio returns. However, before including them in the portfolio, you must analyze the quality of the portfolio and the level of diversification across sectors. Don’t hesitate to take help of a quality advisor if you do not feel confident about doing it yourself.
Last but not the least, don’t ignore monitoring your portfolio even when you invest for the long-term. Remember, you time commitment should be for the asset class and not for the funds in your portfolio. If need be, don’t hesitate to make changes in the portfolio. Many investors often get emotional about non-performing funds and wait endlessly in the hope of better results. More often than not, it can be a fruitless exercise.
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