Sebi in 2018 had introduced two major changes that in a way were aimed at helping investors in selecting and choosing the right mutual fund scheme. Firstly, the fund houses were told to stick to their mandate and secondly, MF schemes were made to benchmark against the Total Return Index which includes dividends as well. Simply put, these two steps were expected to make the task of beating the benchmark a little more difficult for active fund managers. Is it time for the investor to embrace index funds, especially when the markets are at a high? Vikas Gupta, CEO & Co-Founder, Kangaroo Advisors, in an email interview with FE Online talks about the various concerns being faced by investors currently.

With frontline stock market indices near their all-time highs, how is the portfolio of a mutual fund investor looking now? Are the fund values down? If yes, what could be the reason?

The markets are at an all-time high, but the same could be attributed to only 15-odd stocks which are having considerable weightage in the Indices. To put things in perspective, in an index of 50 stocks (Nifty 50), Reliance, HDFC Ltd and HDFC Bank alone carry a collective weightage of 28.62 per cent. So any large movement in these stocks will skew the index movement. Having said that, most large-cap funds are giving decent 7-15 per cent return over a one-year period.

However, the reading on the mid and small-cap side is still painful. Since the 1st Jan 2018, Nifty is +3 per cent, but NSE Midcap is down 27 per cent and BSE Small-Cap is down 36 per cent. This is predominantly the reason for the overall plunge in fund value.

For most retail investors, who have a larger exposure to mid-small cap schemes, the MF portfolio is still in the red. Therefore, building an MF portfolio with proper diversification across market capitalisation is important for long-term wealth creation.

What should new and existing investors do now? Any specific strategies for them?

One simple yet effective strategy for any investor is to always maintain one’s mix of asset allocation. There is a tendency of investors and advisors alike to go overboard in any asset class which has been performing.

Anecdotal evidence shows that during the tech boom in 2000, investors were heavily invested in tech funds and during 2006-07 portfolios were heavily exposed to real estate and infrastructure stocks. Similarly, during 2016- 17, most portfolios were heavily tilted towards small and mid-cap stocks.

We advise investors to have an optimal mix of large-cap, mid-cap and small-cap schemes. Aggressive investors may, however, take a sector bet with not more than 10 per cent of their equity allocation into sectoral funds.

For most investors, the ideal allocation can be:

  • Large Caps: 50 per cent of the overall equity allocation
  • Mid-Caps: 30 per cent of the overall equity allocation
  • Small Caps: 20 per cent of the overall equity allocation

There’s a lot of talk about index funds and their potential to beat actively-managed funds over the long term. How should a retail investor approach index fund and whom do they suit?

The year 2018 saw the regulator clearly define the classification of mutual fund schemes. Before that, a fund branded as a large-cap fund could easily have up to 50 per cent or more exposure to stocks outside the large-cap universe and still have Nifty 50 as the benchmark. Now, if the exposure outside the large-cap universe performed, the fund can easily announce Alpha Generation. And, that was the time when mid and small-cap stocks delivered high returns.

For an investor investing in a fund based on its nomenclature became difficult and somewhat misleading. Post-2018, two things have happened:

1. The Large-cap universe is clearly defined as top 100 stocks in terms of market cap and 80 per cent of the assets of a large-cap fund have to be invested in these 100 stocks only.

2. The Benchmark to be used has to be the Total Return Index(TRI). So, earlier large-cap funds were using Nifty 50 as a benchmark, and now they would have to use Nifty 50 TRI. The difference in the TRI index is of around 1.5 per cent, which is the dividend yield of Nifty.

Primarily because of the above reasons, it has become extremely difficult for the Large-cap fund manager to generate Alpha in Large-cap funds. So sooner than later, Index fund with their low-cost structure will be a suitable substitution at least for the large-cap funds.

Index funds are no-brainer. As the markets mature, it becomes increasingly difficult for the fund managers to outperform Index. There is enough and more evidence of historical data from the developed market to support that argument. Retail investors should definitely look at index funds. I would say at least 50 per cent of the equity allocation of every individual should be in an index fund.

Are mid-cap funds suitable for every investor? What to consider before making them a part of one’s portfolio?

I have always maintained that if we match the time horizons of investment with the time horizon of the asset class, the probability of generating the desired returns is higher:

If an investor follows the above criteria, the probability of getting disappointment is low. Having said that, I would advise investors to enter mid-cap and small-cap funds systematically through the SIP and STP route.