Strategy to review your MF portfolio

I have some questions regarding portfolio management and review of mutual funds:

— How frequently should I review my portfolio?

— What are the criteria to decide whether a fund is performing or not?

— If it is underperforming should I wait for some more time period or immediately sell it?

I am 30 years old and can invest Rs 5000 per month in mutual funds. What is the allocation to be made across different classes of funds (large-cap, diversified, mid-cap and small-cap)?

Amol Kulkarni

Mumbai

We appreciate your intention to come up with a systematic strategy to review your portfolio. These tricky questions pose a challenge to many investors. We will attempt to answer them by giving you some broad guidelines. As a general rule, you can review the performance of your portfolio at least once a quarter, subject to the following exceptions:

A huge rally in stocks in a short span of time warrants a cautious approach for two reasons: one, it could be a sign of a bubble in which case you would be better off encashing those paper profits; or two, your asset allocation – between debt and equity or amongst large-mid- and small-cap funds - would have gone out of kilter. You may have to review and rebalance the portfolio in such a case. In addition to this, any change in your strategy or risk profile too would warrant a review.

Is a fund performing?

When you review your portfolio, assess the performance of the individual funds and their overall contribution to the portfolio returns. Compare the funds returns with that of its benchmark and with funds belonging to the same category. For instance, mid-cap funds may be compared with their respective benchmarks and schemes with a similar strategy of investing in mid-cap stocks.

For this purpose do not take short periods of say one month. Unless it has been an eventful quarter, even a three-month period does not provide much insight. Look at the performance over 6-month, 1 year and two-year time frame. In markets such as the present one, a one and two-year period would reveal a lot on how the fund has tackled the different market phases. If you have held the fund for a long period of five years or more, then see if the three-year return has seen any significant change since the last time you reviewed it.

What is the extent of underperformance that can be tolerated would be the next logical question. Should you sell a fund because it returned 2-3 percentage points lower than its peer? Perhaps not. You will then have to look at the risk-adjusted return (as represented by Sharpe ratio). The fund which appears to have marginally underperformed may actually be doing so because of its lower risk profile. That means, its risk-adjusted return could very well be superior to some of its peers.

Note that, even between the same categories of funds — say within large-cap funds or mid-cap funds — the risk profile tends to vary. Most funds provide this data in their fact sheet. However, a variance of over 10 percentage points in performance should be a cause for concern.

Once you notice that a fund's performance is dipping, look out for the reasons as well. Has the fund' sector calls not worked well? Is the fund holding too much cash? If the fund is able to beat its benchmark but struggles to keep pace with peers, it could be because of the fund's conservative mandate or the high-risk mandate of its peers. Look for these variances before deciding on the next course of action. However, if the fund continues to be a laggard even after 3-4 quarters, it perhaps may be a time to take a call.

An active equity fund seldom holds over 5-8 per cent in cash and equivalents. It also strives to remain invested in equities at all times. Funds from the HDFC basket are an example of such a strategy. Remember that while wrong sector calls occasionally can be tolerated, underperformance due to prolonged periods of poor participation in equity or high cash holdings isn't a good strategy. It defeats the very purpose of your investing in equity funds.

Sell immediately?

Was your fund in the top-10 list or top quartile of the equity fund list and has now slipped slightly lower in the last three or six month period? First thing: Do not panic and sell right away. You do not have to chase returns at all times. Only prolonged periods of underperformance, as mentioned earlier, should prompt you to sell a fund.

In your entire portfolio, there will always be a few funds that aren't great contributors to the overall returns score. Such funds, unless they are a drag the returns of your funds portfolio, need not be sold. A value-fund or a dividend yield fund for instance, may not be the best performer during bull phases, as was seen in the previous market rallies. However, such funds warrant a definite hold if they outperform their category peers. Besides, their value-investing approach may come in handy during periods of market correction. Gold funds or international funds too qualify as primarily diversifiers. So, do not expect these funds to keep pace with domestic diversified funds.

As for intention to hold across market-cap segments, much would depend on your risk appetite. Given your age, we think it would be safe to assume that you can stomach some risks. You can in such a case go for 10-15 per cent of pure large-cap funds, 40 per cent in mid-cap and thematic funds and the rest in diversified funds with a long-term track record.