Good funds alright but are they right for you?

Some of you may be doing your own groundwork on what fund to choose for your portfolio. You may end up with at least half a dozen good funds but then the question of what to choose between them may arise.
Alternatively, some of you check with us on what funds to invest in and then do your own home work too and arrive at your own set of funds. You come up with good funds too and wonder why we chose another set for you and not the ones you picked.

A few others take our suggestions but later see certain other funds being recommended (sometimes in our blog) to another investor and wonder which one is better.

You often wonder or write to us about the differences in choice.
Your question of ‘why this’ or ‘why not this’ can be answered based on few key factors.

What determines your choice?
Your time frame, risk profile and often times the stock/debt market conditions when matched to a fund’s characteristics, determines the choice of funds. Let us suppose you have a three-year time frame and are moderately conservative but wish to hold equities. Let us suppose you have already decided to hold ‘x’ proportion of equities and ‘y’ of debt (asset allocation too is no easy, but then that is another story).

Now, in this case, for your equity choice, let us suppose you drilled down Quantum Long Term Equity, Reliance Equity Opportunities and Reliance Banking. The performance chart suggests that they are all good but which would you choose?
The first is a diversified fund with bias for large-caps; the second is an opportunity fund with bias for mid-caps but can shift its market-cap holdings based on opportunities that the fund sees; the third is a theme fund and is focused on financial services sector.

For a three-year time frame, your risk-taking ability is not high. That means, containing downside becomes important. For that, a fund with a large-cap bias or at best a value bias may be more appropriate than a mid-cap fund. Hence, in this instance, of the choices you made, Quantum may fit your portfolio better than the others. Your low risk-taking ability (given the moderately conservative risk profile) also curtails you from taking on aggressive funds such as Reliance Equity Opportunities.

This is one way to arrive at your pick (after the detailed research of the portfolio and performance). But for this, you need to understand the fund’s characteristics. You can do so by reading articles on the internet or reading the fund’s offer document and often the AMC’s own snapshot of the fund.

If you do not have the time for this what do you do? One way out is to pick earlier periods of down markets and rallying markets and check the performance of these funds. You will find that, often times, the more aggressive fund would have fallen more; although rallying well in an up-market.

Now let us take another example: you try to pick a mid-cap fund in a year like 2011. Your choice was Magnum Emerging Businesses based on its returns and we chose ICICI Pru Discovery for you based on say a four-year time frame and moderate risk profile.

Why the difference? You chose a fund that is very aggressive, churns its portfolio based on short-term stock opportunities and also gets hurt badly in down markets. We chose a value fund with a mid-cap bias, which can deliver well in volatile markets, capitalise on valuation divergence in stocks, contain downsides better but underperform in peak markets. Here, our choice would have been determined by your moderate risk profile and the volatility that prevailed in 2011.
In reality, a lot more factors go in to the choice of funds. We have taken a few simplistic but key factors that decide your choice.

When in doubt, dig for more information or check with your advisor. But before you do so, be clear as to your risk and time frame. If you can afford to lose you capital in the short term of 1-2 years and not let it bother you, or if you lose huge sums of say 30% or more of an entire portfolio and not just a single fund), that too closer to a goal, in markets like the one in 2008 and afford to postpone such goal, only then can you be termed aggressive.
On the flip side, if you are saving to pay your premium one year down the line, you simply cannot call yourself aggressive and choose equity funds. Because this is not a goal you can give a miss!

Pl. note that the fund choices are illustrative in nature and should not be construed as recommendations.