Keep pace with changing times

Financial planning is a long-term process. Short-term developments and market movements should, therefore, not have a bearing on your investment decision. This is the popular refrain among wealth planners. While we remain rooted to this belief, a yearly review of your portfolio is not such a bad idea, especially after a year of regulatory and policy changes, which may directly impact your investment and financial planning.

As the curtain falls on 2010, the country's equity markets have slipped into a volatile phase following the housing loan and 2G spectrum scams, surging interest rates and global economic uncertainties. While the impact of the scams on market sentiments may not last long, the other two concerns may prove to be a drag on the equity markets at least in the first few months of 2011. The volatility, therefore, witnessed now can spill over to 2011.

Reduce your exposure to equity funds if the price-to-earnings ratio of indices continues to remain above 20. 60-70 per cent of your equity portfolio should be in large-caps and the rest in mid-caps for optimum returns in a volatile market.

Consequently, this might have a bearing on mutual funds that have exposure to equities. While each mutual fund portfolio would be different from others depending on a person's needs, risk appetite and future goals, there are some basic principles which can be followed while taking any investment decision.

MONEY TODAY outlines the fundamental dos and don'ts for making an investment decision in the new year.

Rebalance Your Portfolio
A periodic rebalancing or review of your portfolio is an essential part of financial planning, and what better time to review your investments than the last quarter of a financial year. These will be the first three months of 2011, when most of your tax investments are finalised or fine-tuned.

A suitable mix of debt and equity in your mutual fund portfolio, depending on your goals, needs and market conditions, is one of the ways to ensure sustained long-term wealth creation.

If your ideal equity-debt ratio is 70:30 and due to a surge in the market over the past one year your portfolio has largely skewed towards equities, this is the time to either tread back to the 70:30 mix or to cut equity exposure further.

Usually, a price-to-earnings (PE) multiple of 20 or more in major equity indices calls for a cut in your equity exposure. At present, both the National Stock Exchange's Nifty and the Bombay Stock Exchange's Sensex indices are trading at PE multiples of 21-22.

According to Gagan Randev, chief executive officer, Religare Securities, at high PE levels, investors should partially book profits from their equity funds and put the money in liquid funds and short-term debt funds.

Given the emerging scenario in the financial market, how should you adjust your mutual fund portfolio during 2011? Here are some tips based on possible market scenarios.

In a falling market, we recommend investing 100 per cent in large-cap funds or large-cap index funds Navneet Munot Chief Investment Officer, SBI Mutual Fund

Volatile Markets
Volatile equity markets can be unnerving for any investor with high equity exposure. When the markets move in a unidirectional manner-up or down-you could either get in or get out. But the swinging markets over the past one year have made it difficult to take a call. This is the time when the systematic investment plans (SIPs) come in handy.

If equity markets continue to show an upward bias, investors should consider following the asset allocation strategy Sankaran Naren Chief Investment Officer, ICICI Prudential Mutual Fund

Regular investments at fixed intervals (for example, on a monthly or quarterly basis) help in averaging out costs and reducing risk. "In the three-year period beginning December 2007, the equity markets saw one of the biggest crashes followed by a speedy recovery. However, those who had invested through SIPs during the period, gained the most despite the volatility," says Kalpen Parekh, deputy chief executive officer, IDFC Mutual Fund.

According to Sankaran Naren, chief investment officer, ICICI Prudential Mutual Fund, investors should look at long-term SIPs. Another way to insulate your portfolio from market volatility is to have a multi-cap strategy, with the major portion of equity portfolio in large-cap funds and the rest in midcap funds.

"In swinging markets, it is important to split the equity portfolio into large- and mid-caps. Mostly, mid-caps lead the growth and momentum attributes," says Navneet Munot, chief investment officer, SBI Mutual Fund. In an uncertain market, 60-70 per cent exposure to large-cap funds and 30-40 per cent exposure to mid-caps can potentially do well.

Bearish Market
With the Nifty and the Sensex trading in the over-valuation zone, the indices could be in for a correction. A typical asset allocation strategy (shifting between debt and equity funds according to market conditions) takes care of your portfolio in a falling market. In a market undergoing correction, you can gradually increase your equity exposure.

"One can increase weightage to high-risk, high-return assets such as equities and switch money from liquid/debt funds to equity funds if the long-term future of the equity market looks good," says Randev.

In a falling market, the impact on large-cap funds is much less than that on mid- and small-cap funds. Also, large-cap funds usually recover faster than mid- and smallcap funds.

"In a falling market, we recommend investing 100 per cent in large-cap funds or large-cap index funds," says Munot.

Bullish Market
If the markets rise gradually, investors should remain invested without worrying too much about reviewing or rebalancing. However, if they move up disproportionately and valuations get stretched, there is a case for rebalancing.

"In case the equity markets continue to show an upward bias, investors should follow the asset allocation strategy depending upon their objectives as well as their risk appetites. However, they can look at booking some profits periodically," says Naren.

Increasing the weightage of mid-cap funds in your portfolio will help generate higher returns than the broader market. However, large-cap funds should continue to be the core of your portfolio as they lend safety and stability to your portfolio.

Debt Fund Options
Debt funds offer stability and performance when equity funds become overvalued. With interest rates going up, returns from debt instruments have already increased significantly. Interest rates might move upwards if the Reserve Bank of India hikes policy rates to tame the rising inflation.

Therefore, in the short to medium term, debt funds offer good investment opportunities. The first quarter of 2011, in particular, would offer a good entry point in fixed income funds, such as the fixed maturity plans (FMPs) and shortterm bond funds.

"Due to the liquidity squeeze, commercial papers and certificates of deposit are fetching around 9 per cent return. The 10-year yield of government paper is trading in the band of 8.1-8.2 per cent. Investors can increase the allocation to debt schemes due to higher accrual and scope for rates to come down later as headline inflation falls down due to base effect and higher farm output," says Murthy Nagrajan, head, fixed income, Tata Mutual Fund.

Long-Term Savings
As interest rates are slowly rising and are expected to remain stable with a slight upward movement in the medium- to long-term, medium and slightly longer duration bond funds, such as gilt and income funds, are likely to give decent returns.

"For investors with a horizon of two-three years, long-term bond funds or gilt funds could be good options at this juncture," says Jayant Pai, vice-president, Parag Parikh Financial Advisory Service. At present, FMPs are a good pick for generating income if invested till maturity.

Protection From Volatility
While liquid and liquid-plus funds could be used to manage asset allocation between high- and low-risk investments, hybrid schemes such as capital protection-oriented funds, which invest up to 80-90 per cent in debt instruments, can be used to protect the principal amount while trying to generate returns better than bank fixed deposits.

Regular Income
MIPs, which pay regular dividends, can be used as an alternative source of income. However, one must remember that the dividend payout is not guaranteed and is subject to availability of funds.

These are available in various flavours, with different allocation in debt, equities and gold. "MIPs have seen a lot of inflows. The data for the past seven-eight months shows that MIPs are worth Rs 20,000 crore," says Waqar Naqvi, CEO, Taurus Mutual Fund.

Track Regulatory Changes
From January 2011, all mutual fund investors will have to comply with KYC (know your customer) norms, irrespective of the investment amount. Earlier, KYC was mandatory only for investments above Rs 50,000. So, as you prepare for the new year bash, make sure you have all the documents in place and comply with KYC norms to avoid discontinuation of investments.

Another change in the offing is that interval funds, which are FMPs with a premature exit option, will cease to offer the early redemption route from 1 April 2011. The investors who used to prefer interval funds purely for liquidity considerations may now have to reconsider their investment decisions. FMPs are closed-ended funds, which do not allow premature redemptions by paying exit loads.

For retail investors, mutual funds are the best option for longterm wealth creation. It is high time these become the core of their portfolios. The key to reaping maximum benefits is to remain invested in a mix of well-diversified equity and debt funds over the long term.

Current Market Flavours With changing market dynamics, fund houses have come out with new funds to suit investors' needs. As equity markets are likely to remain volatile in 2011 and interest rates to remain high, fund houses are launching appropriate funds. Dynamic Asset Allocation Fund These are the funds that will automatically switch between different asset classes-debt and equity- depending upon certain pre-defined market triggers. Principal Smart Equity fund and Pramerica Dynamic fund are two such funds launched recently. SBI Mutual Fund has also sought approval for a similar product. Capital Protection-Oriented Fund With volatility being the key concern among investors, fund houses have lined up the launch of capital protection-oriented funds. These are conservative hybrid funds with 80-90% investment in debt papers and a lock-in period of three-five years. Recently, JP Morgan Mutual Fund and Sundaram Mutual Fund launched their capital protection funds, while several others are in the process of introducing these. ETFs and Index Funds Virtually, every fund house is launching index funds as the cost of operating such funds is low. Apart from no risk from the fund manager's strategy, index funds are cheaper in terms of lower expense ratios. An index fund tries to replicate its benchmark index by investing in stocks of that particular index with the same weightage as in the index.

WHAT 2011 HAS IN STORE FOR YOU

1. How 2011 will impact you 2. Buoyant market, bullish returns 3. A roller-coaster year ahead 4. Top stock picks for 2011 5. Tracking a positive theme 6. Retail investors should go global 7. Keep pace with changing times 8. Debt funds on solid ground 9. Make the best of uncertainty 10. All set for new, improved cover 11. 'New norms don't include incentives' 12. Invest in a house, cautiously 13. 'Teaser rates don't benefit anyone' 14. Supply crunch to push commodity prices