5 plug and play funds for the DIY investor

With 37 mutual fund categories and counting, investors have multiple layers of decisions to make in building an investment portfolio. There are asset classes to choose, market segments to select and investment strategies to evaluate. The allocations made have to then be monitored and rebalanced over time. Here are 5 scheme categories that make this process easier, especially for those investors who do not have the guidance of a financial advisor to help make these decisions.

Multi Asset Allocation Fund

For investors looking to diversify without the stress of deciding on an appropriate asset allocation and rebalancing, multi-asset allocation funds that combine at least 3 asset classes such as stocks, bonds and commodities like gold can be a one-stop shop. These have to hold a minimum of 10% in each asset class, and fund managers adjust exposure based on their expectation of asset class performance. Investors do not have to make these investment calls; instead, professional fund managers do it for them. The multi asset fund of funds is another product on similar lines and typically is used for life cycle-based targeted investing. “Life cycle fund of fund may be a better option for a DIY investor as it incorporates the life stage into the allocation and reallocation decisions. Investors are likely to get a larger exposure to equity when the investment horizon is longer and so there is no unnecessary sacrificing of yield,” said Deepali Sen, founder, Srujan Financial Advisors LLP.

“A multi asset allocation fund is a passive way of doing asset allocation that investors can use as an interim arrangement as they familiarize themselves with different asset classes and what allocation suits them best,” said Prableen Bajpai, founder, FinFix Research and Analytics. Investors should do some groundwork to understand the strategy adopted by a scheme to allocate and rebalance asset class exposure. Some funds may have static allocation for each asset class while others may take a more market-driven approach. Also check the fund’s approach to investing in large, mid and small cap segments of the equity market and the credit risk they take in the fixed income market. Bajpai also pointed to the risks of concentration that comes in holding all asset classes in a scheme, especially as the kitty grows.

Flexicap Fund

For investors looking to invest across large, mid and small cap segments, flexicap funds provide this option in a single fund. Moreover, investors get the benefit of an expert to decide on the relative attractiveness and risk of each market segment and how to allocate investments across these segments.

Not all flexicaps are the same and investors will need to evaluate how a fund incorporates flexibility into the portfolio. Some funds may dynamically alter the portfolio’s exposure depending upon the relative attractiveness of each segment, while others may invest in stocks of companies that fit their investment rationale irrespective of the segment to which it belongs, and still others may have a preference for a certain segment, say large-caps, and use exposure in other segments to boost returns. Investors selecting this category should be comfortable with the free hand that fund managers are given and the possibility that the fund may go heavy on a segment that may have greater risk. “Flexicap funds could have varying levels of allocation to mid and small segments of the market. You could end up being overweight”, said Sen. Look at past portfolios and fund manager commentary to understand how they intend to manage the schemes.

Multicap Fund

For investors who like to diversify across equity market segments but would be comfortable with a more structured portfolio strategy the multi cap category where the fund has a regulatory requirement to hold at least 25% each in large, mid and small cap segment may be more suitable. Investors therefore have greater visibility of their portfolio and the risk from wrong segment calls by the fund manager is limited. However, the rigidity of the exposure, particularly in small cap stocks, may make the fund riskier. It takes away the risk mitigation that comes from the fund manager actively reducing portfolio exposure to the more volatile and illiquid segments in economic and market downturns.

Investors considering this category must have a longer investment horizon to reap the benefits of a large exposure to companies in the small cap segment of the market, which have longer gestation periods.

Dynamic Asset Allocation Fund

For investors who would like to participate in equity markets but with lower short-term volatility as compared to a pure equity fund, dynamic asset allocation funds may be the answer. These blend equity and debt investments based on pre-defined triggers and valuation models. The triggers, such as price-earning multiples, indicators of market momentum, lead the fund to invest more in equity markets when valuations are low and markets correct and vice versa. The debt allocation cushions the portfolio from steep corrections in equities. It would be difficult for retail investors to replicate this discipline of investing in equity markets on their own.

Consider this category to begin with equity allocations if you are a new investor. Bajpai recommends this category for investors with conservative to moderate risk profile. “Investors who do not have the investment horizon for a pure equity fund, say 5-6 years, can consider this for a lower volatility portfolio,” she said. Investors need to be comfortable with the strategy used by the fund manager to make the allocations and understand that just as the risks are lower, the returns too may be lower in a bull market as compared to a pure equity fund.

Dynamic Bond Fund

For investors looking to protect debt fund investments from the impact of interest rate movements, the dynamic bond funds may fit the bill. These have the flexibility to shift the portfolio to short-tenor securities to follow an accrual strategy when interest rates move up and to long duration bonds when interest rates decline to benefit from a rise in the prices of the bonds. The success of this strategy to a large extent will depend upon the fund manager’s ability to read interest rate trends and position the portfolio accordingly.

Consider this category if you have an investment horizon of at least 3 years because a dynamic bond fund is likely to outperform other debt fund options, such as a short duration fund, when they stay invested through an interest rate cycle. Sen believes the volatility can be unnerving for a fixed income investor. This is an aggressive strategy for a fund to follow and investors should be willing to take the volatility in the returns. The fund manager making a wrong call is a key risk, as is the credit risk that the fund may choose to take.

These fund categories can be used by investors to build a no fuss portfolio and allow a tax-efficient way to rebalance across asset classes and markets. However, investors must have realistic expectations on returns. A fund that invests in equity, debt and gold will not do as well as a pure equity fund in a bull market or a gold fund when gold prices are on a steep rise but they will provide more stable returns. Similarly, in a falling interest rate scenario a long duration fund is likely to outperform a dynamic bond fund that will typically wait to see a change in interest rate trend before increasing the duration of the portfolio. As investible surpluses increase and investors have well-defined financial goals, adopting an asset allocation and product categories that is tailored to the investor’s need and risk preferences will be a more efficient method to getting to goals than choosing the one-size fits all products. Having an advisor who will support in this process will make sure that it is done efficiently.