Thursday, July 26, 2007

Which Mutual Fund to buy??

Usually this question would elicit a smirk from most that I interact with, especially those that have started in their journey in the stock market and have had the beginner's luck. Not forgetting those that have made actually made quite a pile in the current bull run of the markets! But most of the these are such who are a product of the era of the market rising beyond the sky phenomena. For the more seasoned investor it is a serious consideration, especially if you belong to the category of people who don't have a job in the financial industry and also don't have much time to invest in learning the actual financial ratios and techniques for asset valuation.

While I also do belong to the fast driver category with high risk taking capacity, I needed to ponder on the question when I was asked for advice on investment avenues recently. One such was a friend of mine and another a colleague from work. And I was in a fix. While I am aware of some potential high growth stocks, when it comes to belting out the advice I am not ready to take the risk on another's behalf. So I did some research on their part and came up with a equity oriented mutual fund portfolio. This discussion does not include asset allocation strategies and risk mitigation. So I will not be taking up the case of debt oriented MFs or Exchange Traded Funds (ETFs). Also the recommendations are based on today's date and may be revised only after a year or so (essentially keep track but don't fret).

What is a equity oriented fund?
An equity oriented Mutual Fund has the objective of investing 65% of its fund portfolio in equities at the least, and rest may be invested in money market instruments or kept as cash, depending upon the objectives of the fund and the fund management capabilities of the fund manager.

First off the recommendations and then selection criteria will follow. Also given alongside is the value of Rs. 10000 invested 5 years earlier in the funds, as also the current entry loads.

1. Reliance Equity Growth Fund 113820 2.25%
2. SBI Magnum Contra 107550 2.25%
3. Sundaram Select Midcap 103170 2.25%

Criteria for selection

  • Equtiy Diversified - Within equity oriented funds, there are diversified equity funds, midcap/large cap funds, sectoral funds, specialty funds and other flavors. With all the flavors except the diversified you are taking a call on a particular sector of the economy or the type of stocks that the fund would invest in. This is a very good option for those that understand macroeconomics, and those who can identify the peak and bottoms of a sector. But if you are a long term investor, it is necessary to realize that no single sector keeps growing. Almost all sectors are cyclical in the sense that they keep going up and coming down. The best example are the automobiles, cement, steel and such other sectors. So when the objective is diversified, over the long term the fund manager has the freedom to make the call on the up and coming sector.
  • Age of the Fund - All three funds are more than 5 years in operations and have therefore proved their mettle. In fact they might have even undergone change in their fund managers and yet have been able to maintain their performance. Goes to show the strength of the underlying analyst team
  • Assets under management - All of the above funds have more than Rs. 1000 crore under their management. This is also important, so that the fund manager has enough cash to take advantage of any opportunity arising out of market movements. For example if their is a market crash, most people would like to redeem their funds and get it in cash. But the fund manager might be able to identify good valuations of a company that he wants to buy. Large assets under management (AUM) allow the fund manager sufficient room.
  • Time - I have assumed that the person investing in these funds has a long term horizon, say more than 5 years (although 3 years is also good enough) such that any sudden downturn due to sectoral calls, fund manager change or such external factors are nullified.
Mode of Investment
  • Systematic Investment Plan (SIP) - If you don't have money right now but will have it regularly in the future, this is the best option. Through SIP, the law of cost averaging will help to reduce the purchase price of the units in the fund.
  • Systematic Transfer Plan (STP) - If you have a lump sum amount to be invested, it is best to follow this option. In this, the initial money is kept in a liquid fund from which money is withdrawn into the primary fund at pre-defined intervals (monthly recommended). This helps in generating more than the interest rate offered by liquid savings in the bank.
After having said all this, I am sure there are people who are ready to take some sectoral calls. For such people I recommend the financial services sector, the power & energy sector and the darling of all - the real estate and infrastructure sector. For such, I can recommend (with a 3 year view)

  • Reliance Diversified Power Sector fund
  • JM Financial Services Fund
  • UTI Infrastructure Fund
Actually there are no real real-estate funds, except those that are there with high entry barriers (minimum investments in lakhs of rupees).

Also what ever fund you select, it's necessary that you go in for the growth option. To find out the advantages of growth option over the dividend option, read this.

Disclaimer: The risk in the recommended portfolio is borne by the investor, although if the investor is ready to share a part of the profit with me, I have no qualms in bearing the risk also.
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