Equity fund-of-funds is a Prudent Investment

 Retail investors often try to time the market which is not the optimal strategy most of times. Investor should map their equity allocation to their long term financial goals and stagger their investments to achieve the best results from equity.

            The sharp rise in markets and overall improvement in the economic environment has led to investors putting more money in equity mutual funds. The mutual fund industry has also gone into overdrive and has been launching a slew of NFO. However, it is best to advise caution to the retail investors. With valuations at a premium, especially in the midcap and the small cap side, there is a significant possibility of new investors facing disappointment (in terms of returns) in the near term and pull out money at the wrong time, out of fear; if the markets correct sharply. Over the long term, as the understanding of equity as a long term asset class (and not a short term speculative avenue) increases, flows to the equity mutual funds should improve structurally.

            Many conservative investors are opting for hybrid funds now to compensate for lower returns in fixed deposits, as well as to get a flavor of equities. We may see this trend continue going forward. Even balanced hybrid fund and dynamic asset allocation funds tend to be equity biased as and when they try to generate better returns and alpha. While achieving these objectives, these hybrid funds invariably end up taking more risk, which may not always match the risk profile of conservative investors. If these preferred hybrid fund categories are not able to provide downside protection through the stock market volatility as expected, conservative investors may not be comfortable staying on.

                Floating rate bonds are a good investment choice in a rising interest rate environment. As market interest rates move up, coupon rates on these bonds reset to higher levels. However, there is limited stock of quality floater securities available in the Indian debt market and secondary market liquidity is much desired in this segment. So, it would be extremely difficult with an increase in the AUM size in this narrowly focused category to not compromise on the portfolio quality.

                Investors often buy different equity mutual funds to diversify but inadvertently buy funds with similar strategies and portfolios. Diversification in the mutual fund portfolio needs to be backed by proper research. Ideally, 15% allocation should be towards a well-managed value fund, 15% to an ESG focused equity fund and then a layer of 5-6 equity mutual funds diversified across caps and styles.

                Value funds aim to ignore short term market movements and wait patiently for value to emerge as it allows them to generate steady returns over other equity mutual funds is that the companies that are strong on ESG have relatively better long term financial prospects. Whereas, an equity fund-of-funds is a prudent investments option to build the major portion of your equity portfolio is just by investing in one fund. This fund gives investors exposure to funds that are actively managed and lets them rely on the fund manager’s capability to take advantage of the correction and build a robust portfolio.