An asset allocation-based (mix of equity and debt) approach should be followed for portfolio construction. Assuming a moderate risk profile, and given the time horizon of five years, the recommended portfolio mix would be about 50% into equities and rest into fixed-income funds. The equity allocation can be split up as 30% into large-caps, 10% into mid & small caps, and 10% into international equities. For domestic equity allocation consider a multi-cap fund and for exposure to international equities, a global equity fund which invests across major markets. For investment in fixed income, look at accrual fixed income funds with a high credit quality portfolio.
l Is it better to invest in exchange-traded funds as the costs are much less than an actively managed fund? —Sandeep R Singh
Unlike actively managed funds, ETFs save on the research costs and also the registrar & transfer agent (R&T) costs. Hence, the cost involved is much lower than that of active funds. However, investing in ETFs entails the costs of maintaining a demat account and a brokerage charge on traded value. Investors can buy /sell units of active funds directly with the mutual fund at the prevailing price at the close of the day. ETFs on the other hand trade continuously throughout the day like stocks based on the bid-ask price at that instant in the exchange order book, and hence the price of an ETF may deviate from the price of the underlying basket of securities. In recent times, most fund managers, particularly in the large-cap segment, have found it tough to beat the benchmark on a consistent basis.
Hence the increased attention towards passive funds. Be mindful of the risks of investing in passive funds such as security concentration risks and exchange-related liquidity risks. If the underlying index has no cap on security level weights, the index may turn out to have high concentration to select top performing securities, which exposes investors to the company-specific risks of that security. Also, exchange-related liquidity risk is crucial since despite the low costs of the ETF, an adverse bid-ask spread may work against investor interest having a significant impact at exit.
(The writer is director, Investment Advisory, Morningstar Investment Adviser (India). Send your queries to firstname.lastname@example.org)