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Stock picking tips from an expert

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When Sandip Sabharwal was head of equity at SBI Mutual Fund, he was named the ‘Business Standard Equity Fund Manager of the Year 2004-05’.

Today, he is chief investment officer (equity) at J M Mutual Fund. In a chat with mutual fund research organisation Value Research, he spoke about his investing style.

On his stock picking strategy

I am a firm believer in the bottom-up approach to investing. This means I make investment decisions on the basis of evaluating a company on its merits.

Before investing into a company I like to meet the management of the company to get a proper perspective on their capabilities and ability to deliver good returns to its investors.

I also evaluate companies on the basis of various financial ratios and look at growth in sales and profits and trends.

I believe that the bottom-up approach to investing is more efficient than the top-down approach in terms of identifying investment ideas.

Sometimes the analysis starts from a top-down approach. For instance, three years ago when I was in SBI Mutual, we saw that a huge infrastructure boom was likely to happen in India. We then evaluated the companies most likely to benefit — construction companies.

At that time, construction companies were operating quite unprofessionally. We realised that there was going to be a growth in the earnings of these companies. So we analysed and researched various stocks and picked up IVRCL Construction and Nagarjuna Construction. Both did extremely well.

Should I invest in a mid-cap fund?

Similarly, in 2004 we looked at the sugar sector. Oil prices were going up and the sugar cycle indicated that sugar too would be going up. The industry was growing and a number of these companies were setting up plants. So we figured that they would grow rapidly over the next few years. At that time, we picked up Balrampur Chini which gave us a great return.

On how he describes himself as an investor

I am an aggressive growth investor.

When researching stocks, I believe in doing a proper analysis and study and research. Once I am sure that I am going to invest in the stock, I do so with conviction and confidence. You must be willing to put your money behind your bets.

When I make up my mind to buy a stock, I pick it up whether or not other investors are looking at it. Then, I hold onto it with conviction. I am willing to stick to my belief. One also needs to be focused in this field.

But conviction comes from experience, being successful and with time. One also needs to learn from past mistakes after all the market is above everyone.

Why stock picking should be left to the experts

Equity investing is more of an art than a science.

Watch your money grow!

The investor has to have the ability to analyse numbers and ratios. Besides, he must also be able to look at other issues such as management competence, understanding of the business cycle, future business environment, the competitive positioning of the company, the potential of the business in which it operates, if there is and will continue to be a market for its goods or services, etc.

Evaluating a company is not totally scientific. Gut feel and experience play an important role.

Also, the parameters used to pick stocks will vary from business to business.

How to approach mid-cap stocks

If I am looking at a commodity stock, I will not lay as much emphasis on management competence and ability to grow the business. I will consider it but give more importance to the cycle of the business. Is there an upturn round the corner? If yes, then is the company in a position to make use of the growth prospects ahead?

If I am looking at a mid-cap stock, subsequent to doing the business analysis, the management capability is the first thing I will focus on. Since the management in mid-cap companies does not have a proven track record, you have to see whether or not they are able to perform and deliver.

On whether or not there are any stocks in the market that can give good returns this year

High returns from the overall market look improbable at this point in time. But in an economy that is growing so rapidly, one can always find a few good stocks that can grow aggressively.

6 large-cap funds to consider
At the start of last year, no one expected such fabulous returns from real estate stocks. So though the overall market went up 40%, most real estate stocks moved up by 500% to 1,000%.

In the last one year, there are a huge number of companies that have gone up by more than 100%. Every year you will have such kind of companies. As long as economic growth is strong, it creates huge opportunities for companies to grow.

Historically, the long-term return from equity is around 18% per annum. I think this year the overall market growth should be less than that. But, the test for fund managers will be to pick up sectors and stocks that will grow by a much higher percentage.

Value Research is a mutual fund research organisation.

Should I invest in a mid-cap fund?

I have been investing in diversified equity mutual funds over the past six months.

I would like to keep doing so but this time only via a Systematic Investment Plan with select funds. Every month I can devote a total of Rs 15,000 towards this.

I was thinking of focusing on the Equity Linked Saving Schemes of mutual funds and in some mid-cap schemes.

Am I doing the right thing? If you agree, then what would be a good ratio to adopt between the two?

– Kapil Arora

Systematic Investment Plan
You have made the right decision of investing in select funds through the SIP mode.

Too many investors want to time the market when in fact, the market cannot be timed.

The best way to invest in a mutual fund is by regularly investing fixed amounts. When the Net Asset Value is high, you get fewer units for your money. When it is low, you get more units.
Over time it averages out.

For a balanced perspective on the good and bad of SIPs read, How to invest in a mutual fund and Why an SIP is not always great.

Equity Linked Saving Schemes

An ELSS is the mirror image of a diversified equity fund.

This means the fund manager will invest in shares of various companies across various industries.

What sets it apart is the added tax benefit, something a diversified equity fund does not offer.

Investments in ELSSs fall under Section 80C. The limit under this section is Rs 100,000. This is irrespective of how much you earn and under which tax bracket you fall.

Also, there are no sub-limits under this overall Rs 100,000 amount.

So, if you choose, you can invest the entire amount in ELSS or infrastructure bonds. How you utilise the limit of Rs 100,000 is entirely up to you.

All about Section 80C gives you the details about the various investments that fall under this section.

The dividends you earn in an ELSS are tax free.

When you sell the units of these funds, you can benefit from long-term capital gain, under which you don’t have to pay capital gains tax. Read All you want to know about capital gain to understand long-term and short-term capital gain tax.

But, it also carries a lock-in of three years. Therefore, you must invest only that much in the ELSS which will help you save tax.

Secondly, you should be comfortable to part with this money for the next three years.

In any other case, diversified equity funds would make more sense than an ELSS. To help you make a choice, read Which ELSS fund should you invest in?


If the number of shares in a company is multiplied by its current price, the result is market capitalisation.

Based on this figures, companies are categorised as large-cap, mid-cap and small-cap.

When deciding whether or not to invest in mid-caps, there are three steps you must follow.

1. Check to see how much of your existing portfolio has already been invested in mid-caps.

2. Then decide how much percentage of your overall portfolio you want to allocate to mid-caps.

3. Decide whether there is scope to add a mid-cap fund to the portfolio.

Mid-caps have witnessed a tremendous price appreciation over the last year and a half. So they look extremely attractive as of now. For a detailed write up on this, read Why mid-caps are hot.

But, they are very volatile and are susceptible to varying price fluctuations. When the market rises, they rise faster than the large-caps. If the markets fall, they are likely to take a deeper blow than the large-caps.

You should be comfortable with this kind of volatility.

The advantage of a diversified equity fund is that the fund manager has the flexibility to move in and out of mid-caps depending upon his outlook.

However, a mid-cap fund will either invest in mid-caps, or not. If the fund manager believes the stocks are too highly priced or there are not sufficient good companies around, he will leave the money in cash.

Therefore, a diversified fund tends to be more suitable as a core holding for a long-term portfolio. Invest in a mid-cap fund only if you have sufficent money in diversified equity funds.

Watch your money grow!

I was recently chatting with my friend Manmeet.

He is of the firm opinion that he should invest only in equity (shares and mutual funds that invest in shares).

Forget about fixed deposits, post office schemes, bonds and other such investments (such fixed return investments are referred to as debt investments).

His logic: you get the best return in equity, so why concern yourself with the rest?

If that is what you are thinking too, hang on. Investment planning is not just about great returns but also balance and safety.

Here’s a quick primer on how you should invest your money.

Is it a good time to buy shares?
The bull run has clouded everyone’s judgement

No one is denying the fact that some have made millions in this bull run. Even some equity funds (mutual funds that invest in the shares of companies) have delivered exceptional returns, in excess of 100% in a year (a fact Manmeet kept harping on!).

But what people tend to forget is that the equity market is experiencing the most phenomenal bull run in Indian history.

And, since the returns of equity funds depend upon how the equity markets have been performing, they too are going great guns.

What if this changes? It is bound to happen; even if no one knows when.

Go back a few years to the stock market crash in 2000; you will understand the risk involved with investment in equities.

I am not denying that equities are not the best performing asset class over the years and they could make you a great deal of money. All I am saying it that all your money should not go into it.

How long will this bull run last?
Why a balance between equity and debt is needed

With investments, there is always a trade-off.

Higher returns bring with them a higher risk of incurring a loss as well.

The higher the return, the higher the risk.

Equity funds invest in the equity shares of companies, which have the potential to generate handsome returns.

Currently, the bull run is on and everyone is making money. But, in a bear market, one can also incur heavy losses.

Investing in debt may provide lesser returns, but the risk of losing all your money is much less. Also, you don’t have the volatility that equity tends to have.

Therefore, one must always invest in both.

The equity part of the portfolio provides the kick to generate superior returns. The debt component provides stability when equities slump.

An all-equity portfolio tends to be much more volatile.

What’s the balance?

There is no hard-and-fast rule concerning the percentage of equity investment in your portfolio (total investments).

One broad thumb rule states that the debt portion of your total investment should be roughly equal to your age. So, if you are 20 years old, 20% of your investment must be in debt, the rest in equity.

Eventually, though, it depends on the individual.

1. Safety of capital

If safety of capital (the amount you have invested; this is also known as the principal) is your top priority and you can in no way consider losing your money, you may choose not to invest in equity at all.

On the other hand, if you have no problem taking huge risks, you may prefer the bulk of your investments in equity.

2. Time factor

Equities tend to be a bit less risky on a long-term horizon.

Therefore, a person who is planning to invest for about five years or more, and can digest the ups and downs of the market, may prefer to invest more in equity funds.

3. Age

Age too is a factor. A younger person has a much longer time horizon to make up for losses in the equity market. An older person, who is closer to retirement, does not have that luxury.

Hence, depending upon the risk appetite, age and investment horizon, one can decide upon a suitable combination of equity and debt funds.

How to invest

Take the total amount that you would like to invest and decide how much of it must go to equity.


1. List your options

Divide the portion you have selected for investing in debt between investments like the Public Provident Fund, National Savings Certificate, post-office saving schemes, infrastructure bonds and bank fixed deposits.

You could even consider a debt mutual fund. These are mutual funds that invest in debt investments like bonds.

A stock exchange will have a debt market segment and an equity market segment. Just like equity funds trade in shares (in the equity segment), debt funds trade in the debt market segment of the stock exchanges.

2. An alternative to your savings account

If you have some spare cash for a while and do not want to put in the bank, you could try cash funds.

Cash funds are known as ultra short-term bond funds or liquid funds that invest in fixed return instruments of short maturities. Their main aim is to preserve the principal and earn a modest return. So the money you invest will eventually be returned to you with a little something added.

Of course, you will not get the spectacular returns of an equity fund. But you will not face the threat of your investment being reduced to nothing.

To understand cash funds in detail, please read Tired of your savings account?

To locate some good cash funds, please read Great funds to put your spare cash into.

3. Have a fixed time frame?

If you need the money in a particular time frame, say three months or six months, you could consider a Fixed Maturity Plan.

FMPs are mutual fund schemes that last only for a fixed period of time. It could be as little as 15 days or as long as five years.

They invest primarily in fixed return investments like government bonds and money market instruments (very short-term fixed return investments).

To understand FMPs in detail, please read Should you invest in FMPs?

Don’t forget to keep some amount of cash in a savings account too, for emergencies or sudden expenses.


With the amount that you have allocated for equity, you can then decide whether you want to buy some shares directly or only invest in mutual funds.


If you choose to invest in shares, then you must get yourself a demat account and a broker.

Read Buying shares for the first time? to get started.

2. Equity funds

If you choose to invest in an equity funds, you must remember there are various types of equity funds.

For instance, you have sector funds. These are mutual funds that buy the shares of companies of a particular sector. So, if it is an infotech fund, then the fund manager will only buy the shares of infotech companies.

If the sector does well, the returns would be great. If the sector does not do well, the returns could be really bad.

Diversified equity funds invest in the shares of companies of various sectors.

Since diversified equity funds reduce their risk by investing in the shares of companies across different sectors, this makes them less riskier than sector funds.

Then there are mid-cap funds. These are more risky than a diversified equity fund but have the potential to generate better returns too.

To understand mid-caps in detail, read Why mid-caps are hot.

Then there are the contra funds. SBI Contra and Kotak Contra are examples.

These funds follow a contrarian view to investing. This means the fund manager will deliberately bypass the most popular stocks that everyone is chasing and look for stocks that have strong fundamentals but are trading at a significant discount to their intrinsic value. In layman’s terms, this would be a stock whose share price is, say, Rs 15 right now but has the potential to be Rs 100 over a period of time. Yet, it does not feature in the ‘favourite list’ of other stock pickers.

These funds could take substantial time to offer good returns.

Within diversified equity funds too, funds have different risk profiles. Read How risky is your mutual fund? to understand how to a fund’s risk factor.

3. Funds with the tax benefit

You can even consider an Equity Linked Saving Scheme. These are diversified equity funds that also give a tax benefit.

Read Which ELSS fund should you invest in to check out the options.

A mix of both

Apart from diversified equity funds, you can also consider balanced funds. These funds invest around 60% in equities and 40% in debt.

In such funds, the equity part of the portfolio is meant to generate superior returns, the debt component provides stability.

Though the returns tend to be lesser than a diversified equity fund, these funds are suitable for those who are not keen on taking risks or willing invest all their money in equities.

To understand balanced funds better, read Why you must invest in a balanced fund and 5 great balanced funds.

All set?

Do remember, investing is not all about chasing the most favoured investment of the day.

It is more about discipline and strategy.

If you are willing to invest systematically, without paying much attention to the short-term euphoria and slumps, then you are likely to earn good returns in the stock market over a length of time.

But, for your own safety, keep a small portion in debt.

How to approach mid-cap stocks

Tridip Pathak, chief investment officer, Cholamandalam Mutual Fund, firmly believes in Darwin’s theory of evolution which is built on the process on natural selection: as random genetic mutations occur within an organism’s genetic code, the beneficial mutations are preserved because they aid survival.

These beneficial mutations are passed on to the next generation, and over time, they accumulate and the result is an entirely different organism (not just a variation of the original, but an entirely different creature).

Applied to stock markets, the theory explains the status of mid-cap stocks today. According to Pathak, the stage at which mid-caps are now is part of the natural evolution of the market as also the economy.

How? The economy and markets have undergone several mutations over the past decade.

Capital market systems and the regulatory environment have seen a lot of changes over the past few years. And, with the economic liberalisation policies of the 1990s, competitive pressures have increased and tariff protection has come down.

The beneficial changes of this are manifested in the form of a more efficient system, which reduced the risk of systemic failure, and a far more stable macro economic environment and resilient business models.

The survivors in the mid-cap segment are set to evolve further into large-caps in the years to come as the process of ‘natural selection’ continues.

With continuing reforms and high economic growth, a variety of opportunities has opened up for Indian companies.

At this juncture, the risk associated with these companies is significantly lower than, say, a decade ago. “There are far more credible mid-cap stories today than ever before,” Pathak affirms.

There are many other reasons to buy mid-caps. “Many mid-cap stocks have the potential to become large-cap stocks tomorrow and thus create long-term wealth,” says Pathak.

Of the top 50 stocks in terms of market cap, as many as 20 were mid-cap stocks seven-eight years ago as per a study done by Chola Mutual.

“This is a natural process of evolution of companies in a dynamic and fast-growing economy like ours,” Pathak reiterates.

Also, history has shown that mid-cap companies have a higher return profile than large-cap companies in general. Being neither small nor large, mid-cap firms have attractive risk/return profiles.

Again, the mid-cap segment offers a variety of stocks. “There is a large and diverse group of companies to choose from among the mid-cap universe of stocks.

This enables us to create a well-diversified portfolio,” Pathak says. Unlike large-caps, many of these companies are under-researched and provide opportunities for being identified as undervalued companies.

One problem with mid-caps has been the lack of liquidity. But, Pathak says, there is a natural window to create liquidity. Because ownership in large-caps is peaking.

The FII stake in the top 50 stocks in terms of market cap has already crossed 20 per cent, leaving little room for them to buy large-caps.

As a result of this, more and more of their flows are going towards mid-cap stocks. Currently, 20 per cent of the incremental foreign institutional flows come into mid-caps compared to about 5 per cent about three years ago.

While Pathak’s approach is bottom up, he has constructed the portfolio of his recently launched Chola Mid-cap Fund based on four major themes.

Proxies: Companies, which are proxies for large-cap. The idea here is to capitalise on the discount that certain mid-cap stocks trade at where the quality of business is more or less the same.

For instance, take the case of cement. Stocks like Birla Corp and Shree Cement trade at a substantial discount to large-cap stocks like ACC or Gujarat Ambuja.

Based on current prices, ACC’s shares command an enterprise value of $95 per tonne while Gujarat Ambuja trades at $110 per tonne. On the contrary, Birla Corp trades at $55 per tonne while Shree Cement trades at $70 per tonne.

With the cement business set to improve, these smaller companies are likely to benefit at least as much as the larger players. In fact, some smaller players with higher leverage may post better growth in bottomlines due to their higher sensitivity to prices.

Ditto for petrochem companies like Finolex Industries and Polyplex. While the former produces PVC pipes, the latter manufactures PET films. Both are goods plays on the petrochemical cycle.

They are reasonably good proxies for companies like Reliance Industries and IPCL. Since the petrochemical cycle is on an upswing with a favourable demand supply situation, these stocks should do well at the bourses.

Similarly, Chennai Petroleum, a pure refining company, is a good bet in the oil sector, especially at a time when oil marketing companies are seeing their marketing margins being squeezed due to their inability to pass on hikes in crude oil prices to end users.

Strong refining margins coupled with reasonable volume growth makes the stock a good pick. Chennai Petroleum also offers good dividend yield at current levels. Other stocks that come under this category are Ipca Laboratories, Ashok Leyland and Aventis.

All the three of them trade at a discount to their large-cap peers. Ipca trades at a discount to large-cap domestic pharma companies while Aventis is one of the cheapest MNC pharma stocks available at the bourses.

Commercial vehicle player Ashok Leyland also is available cheap compared to competitor and large-cap peer Tata Motors.

Leaders: The second category is stocks, which are large in their own right. These are stocks, which are market leaders in their respective business segments by virtue of the fact that there are no large-cap stocks operating in that segment.

For instance, express company Blue Dart. It has a leading market-share of 30 per cent in the domestic courier business and runs its own aircraft.

Similarly, sugar company Bajaj Hindusthan is betting on the expansion of its crushing capacity and is set to be a large player. It is already the second-largest sugar producer in the country.

Similarly, companies like Gammon India, Ballarpur Industries and Jain Irrigation figure among the top two-three players in their respective fields.

Likewise, ink company Micro Inks is the largest player in its segment with a 35 per cent marketshare in the domestic market. The company would also qualify under the third theme.

Global: The third segment has been a hot selling story among fund managers in the past few months – globally competitive companies. These are firms which operate in established businesses and are taking advantage of their business strengths.

Micro Inks, for instance, derives about 65 per cent of its revenues from exports and has a significant presence in America. It is the 11th-largest ink player in the US markets.

Again, auto ancillary players Sona Koyo and Mico have tremendous potential to tap the exports market. In fact, Mico will see significant upside, thanks to outsourcing by its parent.

Cummins will also benefit from outsourcing by the parent. Voltas is tapping the export market aggressively.

Another big global opportunity that the market is gung-ho about is textiles.

Pathak is betting on Welspun to capture upsides following quota liberalisation in the US after 2005.

Niche technology firm Hexaware Technologies and BPO player (business process outsourcing) MphasiS BFL also qualify under this criteria. Though MphasiS is primarily an IT services company, it is one of the few listed candidates to derive a substantial portion of its revenues from BPO operations.

Sunrise Sectors: These would include companies, which operate in businesses, which are relatively new and are likely to see phenomenal growth going forward.

Sectors like retailing and contract manufacturing are Pathak’s key bets. These are businesses, which are at a nascent stage and are still evolving.

Stocks which fall in this category are Nicholas Piramal, which has decided to be in the contract-manufacturing space, Vimta Labs, which is a pharma export story, and Pantaloon Retail, which is one of the largest retain chains in the country.

Pathak says some of the stocks mentioned above may fall under more than one category.

For instance, companies like Bajaj Hindustan qualify as proxies as well as leaders. Similarly, Hexaware and MphasiS are niche players and at the same time also qualify as globally competitive.

6 large-cap equity funds to consider

With so many funds being frequently churned out, the entire mutual fund landscape is changing into exotica.

While opportunity funds, multi-cap funds, mid-cap funds and dividend yield funds gain in prominence and popularity, the good old fashioned, no-frills, diversified equity fund is getting lost in the crowd.

Finding a good, large-cap dominated diversified equity fund is no easy task.

Here are such funds that have not got carried away by the mid-cap mania, and have yet managed to deliver substantial returns.

Why the stock market is volatile

About these funds

These are diversified equity funds which figure in the top half based on their trailing three-year returns. Trailing returns represent a fund’s gains over a specified period of time, three years in this case. The Net Asset Values and the returns are as of October 7, 2005. The average three year returns of diversified equity funds is 57.77%.

They have allocated at least 60% of their assets (total investments) to large-cap stocks on an average every year since 2001.

For 2005, the average exposure to large-caps during the first six months is taken into consideration.

How to invest in mutual funds
What makes them good large-cap funds?

There are two reasons why we believe that these are good large-cap funds.

First, if a fund did not get tempted by the mid-caps in recent times, then we see little reason why it would compromise on its large-cap orientation in future as well.

Second, with a large-cap heavy portfolio, the fund have obviously done well to remain in the top half of the category over the last three years, a time when mid-caps have been firing from all cylinders.

Balanced funds to consider
The following six funds have made it to our list*

DSPML Opportunities

While looking for investments that are expected to do well, the fund does not compromise on its large-cap orientation. However, it takes sectoral bets at times, making it a little aggressive.

3-year return: 67.88%
NAV: 35.06

Franklin India Bluechip

A 28.45% annualised return since its launch in 1993 speaks volumes about the fund’s ability to perform. Though the fund has dipped slightly in the recent perfromance charts, that doesn’t prevent it from still being one of the top picks in the category.

3-year return: 58.27%
NAV: 82.02

Franklin India Prima Plus

The fund adds a pinch of mid-cap flavour to the large cap dominated portfolio. Over the years, the fund has efficiently managed its mid-cap exposure to generate returns for its investors, while still being large-cap dominated.

3-year return: 56.02%
NAV: 82.23

HDFC Top 200

With a focus on companies mainly drawn from the BSE 200 index, the fund merits consideration in any large-cap bluechip dominated portfolio.

3-year return: 65.92%
NAV: 69.566

Kotak 30

This fund restricts its investment to nearly 30 stocks. It has always maintained a large-cap portfolio thus making it one of the least volatile funds in the category.

3-year return: 59.05%
NAV: 43.22

Principal Growth

With the allocation to large-caps just about averaging 60% for the six month period of 2005, the fund made it to our list by a very narrow margin. After a poor show in 2003, this fund made a smart comeback last year to deliver top-quartile returns.

3-year return: 56.33%
NAV: 34.46

How to invest in mutual funds

What exactly is a portfolio?

In a general sense, all the investments of an investor are collectively referred to as a portfolio. And this portfolio is meant to serve a few particular goals.

Here’s how to build a portfolio of mutual funds.

Is the Super SIP a good investment?
Define your goal

This may come as a surprise. But, you need a distinct portfolio for each goal. Why? Because you will be requiring the money at different points of time.

For instance, if you are saving for your wedding two years down the road and your retirement 30 years down the road, you will invest differently for each.

If saving for your wedding, then you don’t have much time. So your risk cannot be too high. Neither can you put it in an investment which will be locked for a longer duration.

So you would not be able to consider an Equity Linked Saving Scheme which has a three-year lock-in period. These are diversified equity funds with a tax benefit. You will probably have to consider a debt fund (fund that invests in fixed return investments) or a Fixed Maturity Plan or a balanced fund (fund that invests in both shares and fixed return investments).

But, with a 30-year time frame you have lots of time on your side.

You could definitely consider equity funds � funds that invest in shares of companies.

Over long periods of time, the risk of investing in equity (and hence equity funds) is minimal and the rewards you can expect are high.

At the broad level, money that is needed within the next three to five years must be in debt funds while money that is going to be needed after that can mostly be in equity funds.

Why Magnum Contra is a great investment
Define your asset allocation

Which means how much should be split between the various types of funds.

At a higher level, you need to decide how much to invest in equity funds and debt funds.

On the next level, you need to make selections within these broad categories.


The first step that you should take is to invest in diversified equity funds.

In our rating � which takes into account risk and return � we list funds on the basis of a star rating. Five star funds are the best you can have in your portfolio.

The September 2005 list of diversified equity funds has six funds with a five-star rating. HDFC Equity has a below average risk grade and above average returns grade. In contrast, Franklin India Prima has an average risk grade and high returns grade. Thus, compared to HDFC Equity, Prima delivers higher returns but takes more risk in doing so.

This is the kind of insight that should be the key driver in deciding which funds should form the core of your portfolio. The core should be composed of funds that offer stability coupled with returns.

Don’t judge funds based on the short-term performance, always look at the long-term performance.

If you still want to invest in some equity funds, then you could try sector funds and mid-cap funds. You could also look at funds like Kotak Contra and Magnum Contra which buy stocks that are not currently popular with other investors. All these can be referred to as non-core funds.

But look carefully at your current investments before deciding.

Let’s say that you have invested in HDFC Equity and Franklin Bluechip. If you take both the fund manager’s investments into account, 22% of total investments would be in technology stocks and 15% in auto stocks. Now, if you decide to invest in a tech fund or auto fund (both sector funds), you are taking the call that these two fund managers have not invested sufficiently in this sector and you are really keen on investing in such stocks. Go ahead only if you are certain that you want to invest heavily in these sectors.

To compare funds, you need to look at returns and risk. How to compare mutual funds and How risky is your mutual fund? will enable you to do that.


There are ultra-short term funds, known as cash funds, which are suitable for those who want to park surplus money for a very short duration, ranging for a few weeks to a few months.

Read Tired of your savings account? Try this to get a better understanding on such funds.

Then there are short-term debt funds for those who want to invest for a year or so.

Floating rate funds invest in instruments where the interest rate fluctuates depending on the overall interest levels in the economy. When one is unsure of which direction interest rates are headed, this is a good option.

There are also medium-term debt funds which have the potential to deliver higher returns than the above.

Gilt funds are those that only invest in government securities (investments with the government backing).

How many funds?

Even within mutual funds, diversification is a must. You must invest in different types of mutual funds and they should be from different Asset Management Companies (fund houses).

Looking at the actual portfolios that people send us, most investors tend to err on the side of having too many funds, rather than too few.

To make matters worse, many of these portfolios have funds of the same type.

In our opinion, two to four equity funds and one or two debt funds are quite enough for each type of fund.

Let’s say you want to invest in short-term debt funds, floating rate debt funds, large-cap diversified equity funds and mid-cap funds.

What we suggest is:

Short term-debt fund: 1
Floating rate debt fund: 1
Large-cap equity funds: 3
Mid-cap funds: 3

Mutual funds give great returns
Evolving a portfolio

You must monitor your portfolio.

Let’s say a fund might have been an excellent performer years ago but has consistently being underperforming.

In such a case, you should think of selling your units or at least stopping further investments if you are doing it via a Systematic Investment Plan. This is a scheme where you put in fixed amounts every month.

Also, if you have been saving with a 10 year time frame in mind and eight years later a bull run is on, it would be wise to take a look at your investments.

After all, you invested because you needed the money in 10 years time. Now, you need it just two years down the road. If you are making a good profit, sell your units and put them in a fund that is meant for a shorter time frame.

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Get cracking

Constructing a mutual fund portfolio is not rocket science. It just requires a great deal of careful thought.

Remember, it’s your money so don’t blindly play around with it.

Why the stock market is volatile

Last week was bad for the stock market. After reaching a new high of 8821.84 early on Wednesday, the Sensex pulled back dramatically, ending the week at 8491.56.

The immediate reason for the sell-off is pretty simple – Foreign Institutional Investors have been net sellers. And since it is FII money which has been driving the market up, any selling by them is bad news.

But why are FIIs selling?

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It’s not just India

The first thing to understand is that it’s not just the Indian stock market that was affected last week.

Consider this: The S&P 500, a broad-based index of US stocks, lost 2.7% during the week, its biggest weekly drop since April.

The Nasdaq Composite Index, a US market index for technology stocks, lost 2.9%, again its biggest weekly loss since April.

Stocks dropped in Europe as well—market indices for UK, Germany and France ended the week in the red.

Japan’s Nikkei index lost 2.25%, while Australia’s benchmark index lost as much as 4.3% – its biggest weekly drop in four years.

Other emerging markets in Asia too fell.

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What spooked stock markets across the world?

It began with comments by US Federal Reserve (the US central bank) officials that inflation is on the rise in the US. That led analysts to infer that the US Fed will raise interest rates further in its next two meetings this year.

The Fed has already raised its benchmark Fed Funds rate (the rate at which it lends to other banks) to 3.75%, in a series of rate hikes.

That raised several concerns:

1. With interest rates going up, growth in the US would slow.

2. With borrowing becoming more expensive, hedge funds would be hit. These are funds which borrow money in the US at low interest rates to invest in emerging markets at higher returns.

3. Mortgage rates in the US would rise, and that could burst the current bubble in the US housing market.

Now let us look at these factors in detail.

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How does this affect us?

To understand why higher interest rates in the US are such a problem for emerging markets like India, consider how the global economy works at present.

Essentially, low interest rates in the US have led to a boom in housing.

Many individuals could take loans at low rates to buy homes.

Those with homes felt richer with the rise in house prices.

Since the property prices rose, many were able to raise money on their house property (loans against property).

People were able to refinance their mortgages at lower rates (take a fresh loan at a lower rate of interest).

Low interest rates also led to increased borrowing of all kinds, including more credit card debt and other loans.

With this money, the US consumer bought all kinds of goods and services, and much of these goods and services are produced in countries like China and India. So the US consumer has been the main engine for the world economy.

Now consider the other side of the equation.

What did countries like China do with the money earned from exporting to the US? They invested it back into US bonds. That extra demand for US bonds meant that the prices of bonds rose. As a result, their yields fell.

Yields on bonds move inversely to their price. For instance, suppose a bond of Rs 100 has an interest rate of 10%. Let’s say demand for that bond increases. When demand increases, prices increase. If the price of the bond (trading in the debt segment of the stock exchange) goes up to Rs 110, the yield becomes 10/110 or 9.09%. Conversely, if the price of the bond falls to Rs 90, the yield goes up to 10/90 or 11.11%.

It is because countries like China have been ploughing back their money into the US that the yield of the US 10-year bond has not increased in spite of the series of rate hikes by the US Federal Reserve.

In other words, while the Fed has raised short-term interest rates, the long-term yields have not followed suit. This has enabled a virtuous circle of low interest rates, high consumption and strong emerging market exports to continue.

Another consequence of the low interest rates in the US has been that many speculators have borrowed cheaply and used the money to invest in other assets, such as emerging market stocks and bonds. This has driven up the price of these assets (as explained above).

Also, since yields and interest rates in the US are low, investors will move their money to be invested in places where returns are higher.

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Why higher US interest rates are a problem

The worry is that if interest rates now increase too much, this circle will become a vicious one—–higher interest rates will lead to money flowing back to the US from emerging markets, consumption in the US will decline, world growth will slow, and stock markets across the world will decline, with emerging markets being particularly hard hit.

In 1994, a series of rate hikes by the Fed had led to money flowing out of emerging markets, and many bearish analysts have been warning of a repeat of that scenario ever since the Fed started to raise rates again from last year.

In fact, the plunge in the Indian market in May last year, attributed to the election results in which the NDA lost, was actually part of a meltdown in emerging market stocks due to fears of a Fed rate hike.

So far, these worries have been unfounded.

Stocks are still a good bet

Will it be different this time?

One comfort is that the price of oil has also gone down, and commodity prices too have declined. This will remove some of the worries about higher inflation.

The second source of comfort is that the US long-term bond yield has still not reached the 4.5% level, which is seen by some analysts as a signal of danger.

Third, although housing prices have declined a bit in the US, there are no signs of any collapse.

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India and the world

As the above analysis shows, what will happen to the Indian market is largely dependent on what happens to the global markets.

It also doesn’t help that Indian stock prices are now very high, which means that international money could flow to other stock markets around the world where the stocks are priced more reasonably.

However, while FIIs may sell, local mutual funds have raised a lot of money, and that would be invested back to the market. Recall that in May, while FII flows were tepid, local mutual funds continued to buy, providing support to the market.

Nevertheless, last week’s steep drop is a timely reminder to investors about the risks of investing at these high levels in the market, and the need for a great degree of caution.

Written by Bhushan Kulkarni

February 6, 2007 at 8:53 am

Posted in Uncategorized

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