A short note on mutual fund portfolio

रहिमन देख बड़ेन को, लघु न दीजिये डारि।

जहाँ काम आवै सुई, कहा करै तरवारि॥~*~॥

Modi-led victory of BJP and NDA has brought the much needed cheer back on the Dalal Street. This has resulted into lot of re-rating of stocks and sectors and as usual the devil lies in the excess.

The following statistics reveals some interesting but not unexpected trends of the last year and a half:

Period	July 2006 – June 20013 (7 years)	July 2007 – June 20014 (7 years)	July 2008 – June 20015 (7 years)	July 2006 – June 20015 (9 years)
Mid and Small Cap Funds	9.0	11.0	18.4	16.2
All Mutual Funds (older than 9 years)	9.6	10.0	15.1	13.9
Excluding M&SC Category	9.7	9.8	14.6	13.6
Large Cap Funds (+Sensex/Nifty ETF)	9.3	9.0	12.7	12.2

 

Before Modi: The large cap funds, which are supposed to provide stable and somewhat tepid returns, were faring a bit better than the mid-and-small cap funds, which are supposed to be volatile but are capable of delivering big. The smaller fares clocked 9.0% whereas the leaders delivered 9.3%. The average market clocked 9.6-9.7%, mainly led by some specific sectors like FMCG and Pharma.

With Modi: The large cap funds and the average market both stayed at roughly the same level of performance (slight degradation for the former and slight improvement for the latter) whereas the mid-and-small cap funds moved up significantly to a respectable 11%. It would have been nice if all categories moved in sync from there. But that’s only a desire and the reality is very different.

After Modi: The large cap funds moved up by about 2.5% absolute and the average market excluding the mid-and-small cap funds moved by about 4.5% absolute. However, the mid-and-small cap category moved up by a whopping 7.5% absolute. The law of averages tells us that such over-performance is not likely to sustain itself. It could if it was a single company, but we are discussing a whole country here.

Following possibilities exist in the near future (3-5 years which is mid-term in equity investing):

• The bull run continues:
  • We will see the large cap funds delivering superior returns from this point, taking their average performance to long term mean of around 15%. In this scenario, one can expect these funds to clock 16-17% per annum or more from current market levels.
  • The mid-and-small cap funds will also revert to the long term mean of around 15% and this will mean them clocking something in the range of 13-14% per annum or less.
• The bull run subsides:
  • We will see extremely poor performance of the mid-and-small cap funds. The average returns could range from a bad 6-7% to a tragic 2-3%. There could even be a possibility of negative returns, though that is not very likely for investments done via SIP.
  • The large-cap funds will also give a poor performance but it will be more stable and should lie somewhere in the bad 8-9% range or respectable 11-12% range. The SIP investments might clock a bit better than the lumpsum ones.
• Start of a bear market / catastrophic local or global events
  • This is conjecture territory and nobody can predict anything about such scenario. However, it is certain that the mid-and-small cap funds will perform very poorly compared to the funds investing in companies with larger market capitalization.

It is clear that the recent rally in mid-cap and small-cap stocks is not going to be sustainable and the sanity will return the market. The sooner the better for the bigger bubbles burst the worse.

There will certainly be a handful of hardworking or fortunate companies that will transition into the large cap territory due to their good fundamental performance. But that is a matter of individual stock study. The segment is poised to deliver some pain in the medium term.

A possibly sensible (all-weather) portfolio could be as follows:

• Large-cap funds – 30-40%
• Multi-cap funds – 30-40%
• Mid-small-caps – 10-20%
• Balanced funds – 10-20%

If you have a similar, or even a different, relative allocation determined based on your risk appetite and return expectation, there is no need to alter it only because some stupid fund returned 50% in the last one year. And do remember to check that fund’s performance 3-5 years from now.

If you do not need the money in the next 8-10 years, rest assured that the equity funds provide the best risk-adjusted returns and that the large-cap (and multi-cap) funds help you reach your goals (possibly a bit slowly) without giving you sleepless nights. Bite only what you can chew and do not take unnecessary risk with your long term goals. To finish first, you need to first finish.

PS: It should be obvious to the people who understood the opening couplet that here the small refers to the large-cap funds that have done (relatively) poor during the recent bull run.