The fine art of balancing risk and returns

Mutual funds could be the best avenue for the risk-averse While equity as an asset class has the potential to outperform other asset classes, it is vital to select the right funds for investing
O F LATE, the equity market is getting used to the habit of touching a new lifetime peak quite often. As the markets turn volatile, even seasoned investors are forced to turn to wards mutual funds for fresh exposure in the light of the risks involved in taking random exposure to stocks. Mutual funds offer a lot of options through equity and equity-oriented funds to those who do not want to take a headlong plunge into equities.

While equity as an asset class has the potential to outperform other asset classes, it is vital to select the right funds for investing. A better understanding of these funds will go a long way in getting the best out of them, and also knowing what to expect and what not from them. In this context, an investor should keep in mind that equity schemes are meant for long-term investing and they call for the discipline of investing regularly in order to build capital over a period of time.

Let us look at each one of them and see what they have to offer: BALANCED FUNDS BALANCED funds make strategic allocation to both debt as well as equities. It mainly works on the premise that while the debt portfolio of the scheme provides stability, the equity one provides growth. It can be an ideal option for those who do not like total exposure to equity, but only substantial exposure.

Since the exposure limit to equity and debt is pre-determined, an investor can retain the control on the exposure level to both, besides enjoy an advantage of automatic rebalancing by the fund manager for making its dividend taxfree. However, the downside is that since balanced funds need to have 65 per cent exposure to equities to be eligible for tax-free status on dividend and longterm capital gains, the first time investors may feel a little uncomfort able. EQUITY DIVERSIFIED FUNDS A DIVERSIFIED fund is a fund that contains a wide array of stocks. The fund manager of a diversified fund ensures a high level of diversification in its holdings, thereby reducing the amount of risk in the fund. In a typical diversified fund, the fund manager has the freedom to invest across industries as well as various market segments i.e. large cap, mid cap and small cap. Most fund houses have internal guidelines for fund mangers with regard to the maximum exposure in an industry or segment.

DIVERSIFIED FUNDS 1 Flexicap/Multicap Fund: These are by definition, diversified funds. The only dif ference is that unlike a normal diversified fund, the offer document of a multi cap/flexi cap fund generally spells out the limits for minimum and maximum exposure to each of the market caps. To that extent, an investor retains control on the exposure to each market segment. This is not possible in a typical diversified fund.

2 Contra fund: A contra fund invests in those out-of-favour companies that have unrecognised value. It is ideally suited for investors who want to invest in a fund that has the potential to perform in all types of market environments as it blends together both growth and value opportunities.

3 Index fund: An index fund seeks to track the performance of a benchmark market index like the BSE Sensex or S&P CNX Nifty. Simply put, the fund maintains the portfolio of all the securities in the same proportion as stated in the benchmark index. For an individual investor, it is practically impossible to create a portfolio that matches this. The downside of investing in an index fund is that it forfeits the possibility of earning above-average returns that a good quality diversified fund may be able to provide over the longer term.

4 Dividend Yield fund: A dividend yield fund invests in shares of companies hav ing high dividend yields. Dividend yield is defined as dividend per share divided by the share’s market price. Most of these funds invest in stocks of companies having a dividend yield higher than the dividend yield of a particular index, i.e. Sensex or Nifty. The prices of dividend yielding stocks are generally less volatile than growth stocks. Besides, they also offer the potential to appreciate. High dividend payout means that there is enough cash generation in the business.

Among diversified equity funds, dividend yield funds are consid ered to be a medium-risk proposition. However, it is important to note that dividend yield funds have not always proved resilient in short-term corrective phases. EQUITY LINKED TAX SAVINGS SCHEME ELSS is one of the options for investors to save taxes under Section 80 C of the Income Tax Act. They also offer the perfect way to participate in the growth of the capital market, having a lock-in period of three years. Besides, ELSS has the potential to give better returns than any traditional tax savings instrument.

Moreover, by investing in an ELSS through a Systematic Investment Plan (SIP), one can not only avoid the problem of investing a lump sum towards the end of the year but also take advantage of “averaging”. SECTOR FUNDS THESE funds are highly focused on a particular industry. The basic objective is to enable investors to take advantage of industry cycles. Since sector funds ride on market cycles, they have the potential to offer good returns if the timing is perfect. However, they are bereft of downside risk protection as available in diversified funds.

Sector funds should constitute only a limited portion of one’s portfolio, as they are much riskier than a diversified fund. Besides, only those who have an existing portfolio should consider investing in these funds. THEMATIC FUNDS A THEMATIC fund focuses on trends that are likely to result in the ‘out-performance’ by certain sectors or companies. In other words, the key factors are those that can make a difference to business profitability and market values.

However, the downside is that the market may take a longer time to recognise views of the fund house with regards to a particular theme, which forms the basis of launching a fund. EXCHANGE TRADED FUNDS AN Exchange Traded Fund (ETF) is a hybrid product that combines the features of an index fund. These funds are listed on the stock exchanges and their prices are linked to the underlying index. The authorised participants act as market makers for ETFs.

ETFs can be bought and sold like any other stock on an exchange. In other words, ETFs can be bought or sold any time during the market hours at prices that are expected to be closer to the NAV at the end of the day. Therefore, one can invest at real time prices as against the end of the day prices as is the case with open-ended schemes.

There is no paper work involved for investing in an ETF. These can be bought like any other stock by just placing an order with a broker.

(Hemant Rustagi is CEO, Wiseinvest Advisors Pvt Ltd)
O F LATE, the equity market is getting used to the habit of touching a new lifetime peak quite often. As the markets turn volatile, even seasoned in- vestors are forced to turn to- wards mutual funds for fresh exposure in the light of the risks involved in taking random exposure to stocks. Mutual funds offer a lot of options through equity and equity-oriented funds to those who do not want to take a headlong plunge into equi- ties. While equity as an asset class has the po- tential to outperform other asset classes, it is vital to select the right funds for invest- ing. A better understanding of these funds will go a long way in getting the best out of them, and also knowing what to expect and what not from them. In this context, an in- vestor should keep in mind that equity schemes are meant for long-term investing and they call for the discipline of investing regularly in order to build capital over a period of time. Let us look at each one of them and see what they have to offer: BALANCED FUNDS BALANCED funds make strategic alloca- tion to both debt as well as equities. It mainly works on the premise that while the debt portfolio of the scheme provides sta- bility, the equity one provides growth. It can be an ideal option for those who do not like total exposure to equity, but only sub- stantial exposure. Since the exposure limit to equity and debt is pre-determined, an in- vestor can retain the control on the exposure level to both, besides en- joy an advantage of au- tomatic rebalancing by the fund manager for making its dividend tax- free. However, the down- side is that since bal- anced funds need to have 65 per cent expo- sure to equities to be eli- gible for tax-free status on dividend and long- term capital gains, the first time investors may feel a little uncomfort- able. EQUITY DIVERSIFIED FUNDS A DIVERSIFIED fund is a fund that con- tains a wide array of stocks. The fund man- ager of a diversified fund ensures a high level of diversification in its holdings, thereby reducing the amount of risk in the fund. In a typical diversified fund, the fund manager has the freedom to invest across industries as well as various market seg- ments i.e. large cap, mid cap and small cap. Most fund houses have internal guidelines for fund mangers with regard to the maxi- mum exposure in an industry or segment. DIVERSIFIED FUNDS 1 Flexicap/Multicap Fund: These are by definition, diversified funds. The only dif- ference is that unlike a normal diversified fund, the offer document of a multi cap/flexi cap fund generally spells out the limits for minimum and maximum expo- sure to each of the market caps. To that ex- tent, an investor retains control on the ex- posure to each market segment. This is not possible in a typical diversified fund. 2 Contra fund: A contra fund invests in those out-of-favour companies that have unrecognised value. It is ideally suited for investors who want to invest in a fund that has the potential to perform in all types of market environments as it blends together both growth and value opportunities. 3 Index fund: An index fund seeks to track the performance of a benchmark market index like the BSE Sensex or S&P CNX Nifty. Simply put, the fund maintains the portfolio of all the securities in the same proportion as stated in the benchmark in- dex. For an individual investor, it is practi- cally impossible to create a portfolio that matches this. The downside of investing in an index fund is that it forfeits the possibil- ity of earning above-average returns that a good quality diversified fund may be able to provide over the longer term. 4 Dividend Yield fund: A dividend yield fund invests in shares of companies hav- ing high dividend yields. Dividend yield is defined as dividend per share divided by the share’s market price. Most of these funds in- vest in stocks of compa- nies having a dividend yield higher than the div- idend yield of a particu- lar index, i.e. Sensex or Nifty. The prices of divi- dend yielding stocks are generally less volatile than growth stocks. Be- sides, they also offer the potential to appreciate. High dividend payout means that there is enough cash generation in the business. Among diversified eq- uity funds, dividend yield funds are consid- ered to be a medium-risk proposition. How- ever, it is important to note that dividend yield funds have not always proved resilient in short-term corrective phases. EQUITY LINKED TAX SAVINGS SCHEME ELSS is one of the options for investors to save taxes under Section 80 C of the Income Tax Act. They also offer the perfect way to participate in the growth of the capital mar- ket, having a lock-in period of three years. Besides, ELSS has the potential to give bet- ter returns than any traditional tax savings instrument. Moreover, by investing in an ELSS through a Systematic Investment Plan (SIP), one can not only avoid the problem of investing a lump sum towards the end of the year but also take advantage of “averag- ing”. SECTOR FUNDS THESE funds are highly focused on a par- ticular industry. The basic objective is to en- able investors to take advantage of industry cycles. Since sector funds ride on market cy- cles, they have the potential to offer good re- turns if the timing is perfect. However, they are bereft of downside risk protection as available in diversified funds. Sector funds should constitute only a lim- ited portion of one’s portfolio, as they are much riskier than a diversified fund. Be- sides, only those who have an existing port- folio should consider investing in these funds. THEMATIC FUNDS A THEMATIC fund focuses on trends that are likely to result in the ‘out-performance’ by certain sectors or companies. In other words, the key factors are those that can make a difference to business profitability and market values. However, the downside is that the market may take a longer time to recognise views of the fund house with regards to a particular theme, which forms the basis of launching a fund. EXCHANGE TRADED FUNDS AN Exchange Traded Fund (ETF) is a hy- brid product that combines the features of an index fund. These funds are listed on the stock exchanges and their prices are linked to the underlying index. The autho- rised participants act as market makers for ETFs. ETFs can be bought and sold like any oth- er stock on an exchange. In other words, ETFs can be bought or sold any time during the market hours at prices that are expected to be closer to the NAV at the end of the day. Therefore, one can invest at real time prices as against the end of the day prices as is the case with open-ended schemes. There is no paper work involved for in- vesting in an ETF. These can be bought like any other stock by just placing an order with a broker. (Hemant Rustagi is CEO, Wiseinvest Advisors Pvt Ltd)