How to build a portfolio of best equity mutual funds with a single fund

Diversification is one of the basic tenets of investing. The objective, after all, is to build an efficient portfolio of wealth-creating mutual fund schemes, whereby investors achieve their envisioned financial goals with the risks mitigated, particularly when investing in equities.

Any investor while building a portfolio of best equity mutual funds should take note of the two worthy quotes of legendary investor, Warren Buffett, famously called the Oracle of Omaha, when it comes to diversification:

“Wide diversification is only required when investors do not understand what they are doing”

AND

“Risk can be greatly reduced by concentrating on only a few holdings.”

Financial advisors would also appreciate that over-diversification may not always be in the best interest of investors/clients. One needs to hold an optimal number of best mutual funds in his/her portfolio.

And given the plethora of mutual fund schemes, you may know that constructing a portfolio of the best mutual funds can be a daunting task. There are star ratings available, of course, but it would not be very appropriate to base your investment decisions entirely on star-rated funds (it can be used just as a starting point).

So, then how can the investor own a set of best equity-oriented mutual funds?

An equity-oriented Fund of Fund scheme with a commendable track record can be the answer. It facilitates the investor to have exposure to 5 to 10 best equity-oriented mutual funds by investing in one single fund.

The task of selecting the best mutual fund schemes is left up to the expertise of the fund manager, who will do so after extensive research. This is particularly useful for Investors who do not have access to full-fledged mutual fund research.

Here are five key reasons to consider an equity-oriented Fund of Fund:

1. Multidimensional Diversification: Investing in equity Fund of Fund offers extra layers of diversification: across fund management styles, across market capitalisations, and multiple fund managers. As a result, the risk involved in the journey of wealth creation is mitigated and the gains are optimised for the investor.

2. Research-backed Professional Fund Management: The fund manager carries out comprehensive research, applying quantitative and qualitative parameters to pick the best mutual fund schemes.

Under quantitative analysis, the focus is on performance (returns + risk) across time frames (1-year, 3-year, 5-year, since inception) and market cycles (i.e. bull and bear phases), while under qualitative aspects the emphasis is on the portfolio characteristics, the proportion of AUM actually performing, funds-to-manager ratio, how has the track-record of particular fund manager been, the investment processes & systems at a respective fund house and so on. Meeting the fund manager personally is also a part of the process to understand the qualitative aspects of the fund under consideration.

3. Active Portfolio Monitoring and Review: As a part of the fund management activity, the health of the portfolio is tracked as well; not just to achieve the investment objective of long-term capital, but to outperform the benchmark returns and provide investors’ with better returns i.e. generate alpha!
If the equity Fund of Fund has not been able to achieve that over time, then the fund manager actively prunes the holdings to weed out the duds and replace them with well-deserving and better performing schemes, to make sure the investors’ portfolio is on-track to accomplishing the envisioned financial goals. This, therefore, eliminates the hassle of picking and tracking investment in multiple schemes for a financial advisor.

4. Units can be held in demat mode: The units of an equity Fund of Fund can also be held in a dematerialised (demat) mode like in case of stocks and other mutual fund schemes. This makes transacting and tracking the portfolio easy as opposed to keeping track of physical account statements.

5. Helps reduce the cost of investing for investors: Usually, the expense ratio of a well-managed equity Fund of Fund from a process-driven fund house is low. As opposed to investing in multiple schemes with separate folios and attract an expense ratio for each, the equity Fund of Fund is a smart way of investing in multiple schemes and keep the cost of investing low.

But do note that an equity Fund of Fund scheme is classified as a non-equity scheme – i.e. debt-oriented scheme from taxation angle. Both long term and short term capital gains tax are applicable. Here the short term is categorised as a period of up to or less than 36 months. And the long term refers to any period more than 36 months.

Short Term Capital Gains (STCG) will be taxed as per the marginal rate of taxation applicable to the investor/client, as per his/her Income Tax slab.

The Long Term Capital Gain (LTCG), on the other hand, on gains of units held for more than 36 months and above attracts a 20% tax with indexation. With the indexation benefit, as you may know, the investor can counter inflation even if his/her purchasing power may not have changed. If the equity-oriented Fund of Fund has generated appealing returns, the effective post-tax returns can be rewarding.

Who should invest in an equity-oriented Fund of Fund?

If the investor/client has appetite for high risk, the broader investment objective is capital appreciation, wants to accomplish long-term financial goals (viz. child’s higher education, child’s wedding expenses, and retirement, among many others), and has an investment time horizon of at least 5 years; an equity Fund of Fund that offers multidimensional diversification and benefits, can be considered to build a portfolio of the best mutual funds.

This Article was authored by Mr. Jimmy Patel, MD & CEO Quantum Asset Management Company Pvt. Ltd. and was published in Financial Express on December 01, 2019

Disclaimer, Statutory Details & Risk Factors:

The views expressed here in this article / video are for general information and reading purpose only and do not constitute any guidelines and recommendations on any course of action to be followed by the reader. Quantum AMC / Quantum Mutual Fund is not guaranteeing / offering / communicating any indicative yield on investments made in the scheme(s). The views are not meant to serve as a professional guide / investment advice / intended to be an offer or solicitation for the purchase or sale of any financial product or instrument or mutual fund units for the reader. The article has been prepared on the basis of publicly available information, internally developed data and other sources believed to be reliable. Whilst no action has been solicited based upon the information provided herein, due care has been taken to ensure that the facts are accurate and views given are fair and reasonable as on date. Readers of this article should rely on information/data arising out of their own investigations and advised to seek independent professional advice and arrive at an informed decision before making any investments. Please visit – www.quantumamc.com/disclaimer to read scheme specific risk factors.

Above article is authored by Quantum.

View All