I have been investing in equity-oriented and balanced mutual funds for about 8 years. I want to buy some debt funds too. What all should I keep in mind while making a choice? My horizon is about 10 years, and this is not for the core part of my portfolio.
If your investment horizon is long, then you need not worry too much about the impact of interest rates on your investment. Having said that, it is indeed a good time to invest in debt funds as the falling interest rate scenario will benefit some classes of debt funds such as dynamic bond funds. But you need to mix them with income accrual funds to ensure that your returns are sustained even after the rate cycle is over.
There are only a few things to keep in mind while making the choice in these two categories. In dynamic bond funds, go with a fund that has a good track record (of not less than 3 years) and has performed well across calendar years. You can consider the period of 2011-16 to see which funds have been consistent.
In the income accrual category, go for funds that do not take excessive credit risk; i.e., do not have too much exposure to AA and lower-rated instruments. In both these categories, do not go for funds with less assets under management (AUM), since any exit by a single large investor can impact returns. You can consider funds with AUM of Rs500 crore and above for this purpose.
Remember that debt fund holdings of over 3 years enjoy capital gains indexation benefit. This will ensure that you earn fixed deposit (FD)-plus returns.
When should one exit a fund? What parameters will help in taking that decision?
The decision about exiting a fund or staying invested must be made in the context of why one made the investment in that fund in the first place.
Investors may invest in a fund to provide a balance to a portfolio (debt funds, for example); sometimes, they may invest to provide a high-risk, high-return option (small or micro-cap funds, for example); sometimes, it might just be to provide a hedge against overall equity market performance (gold funds, for example). The idea here is that every fund in a person’s portfolio should play a role and have a purpose. If that is the case, then the decision to exit becomes easy, if the fund is not performing that role effectively in the portfolio. Of course, at times, the portfolio goals might change mid-way, and this could also result in re-orientation of the portfolio by shuffling funds around. Either way, the purpose of investments and fund choices determine when to exit and which funds to exit from.
One could also consider exiting a fund at the time of periodic portfolio reviews. At such a time, investors would need to consider which funds have persistently underperformed since the previous review.
Also, if a fund is lagging its peers in its category through the year (by moving to the third or fourth quartile of funds in its category), again, that would be a red flag. Other considerations would be if a fund has moved significantly in terms of its mandate since the time you invested, and it no longer fulfils the role you had given it in the portfolio. For example, a mid-cap fund could grow in size and start acting more like a diversified or a large-cap fund. In such a situation, you would need to take stock of the portfolio in this new light and evaluate if the fund still belongs there.
I have seen Mint50, which also talks about the expense ratio of the schemes. Does that play a big role? If a fund performs well, is that not enough?
You are correct to a large extent. In India, all fund performances are reported after the expense ratio has been taken into account, and hence the magnitude of that number alone should not make a difference in terms of choosing between schemes. However, expense ratio plays an important role in two scenarios. The first is when it comes to debt funds.
In these funds, the ‘alpha’ or incremental returns that the funds provide to an investor over the market are relatively low (compared to equity funds) and a higher expense ration will make an impact on the returns. So, when choosing between similar debt funds, one should prefer a fund with the lower expense ratio. The second scenario is when choosing between the ‘regular’ plans and ‘direct’ plans of a mutual fund. The direct plan variant of a mutual fund, meant for investors who can plan and decide on their own as to where to invest, carries a lower expense ratio while investing in the same portfolio as the regular plan variant of the same fund.
An investor who is confident of managing her own investments and fund selections should hence prefer direct plans and stand to gain from the higher returns.
Srikanth Meenakshi is co-founder and COO, FundsIndia.com.
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