Sensex Near 40,000! Do You Have A Robust Investment Strategy In Place?
May 02, 2019

Author: Rounaq Neroy

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(Image source: unsplash.com )

The Indian equity market is witnessing an election rally. The S&P BSE Sensex is near the all-time high of 39,487.45 points (touched on April 18, 2019). The market, perhaps, is anticipating the Modi-led-NDA government getting a second term in the on-going general elections in absence of a strong leader in the opposition who can take on the Prime Minister, Narendra Modi.

But honestly which government comes to power has never mattered to the Indian equity market. What has mattered the most is the policy, reforms, and earnings.

Speaking of reforms, the Goods & Services Tax (GST), Bankruptcy Code, Digital India, Start-up India, Make in India, skill development, affordable housing, emphasis on better infrastructure (Bharatmala Pariyojana), bank re-capitalisation, to name a few; have gone well-appreciated by Foreign Portfolio Investors and even Domestic Institutional Investors (DIIs).

The government now has to efficiently implement reforms by creating job opportunities. Currently, the opposition is targeting the current dispensation since India is caught in a job muddle -- the unemployment rate has touched a 45-year high.

Besides the National Security and the Hindutva agenda, having good job opportunities and enjoying a respectable standard of living with job- in-hand is what the people expect.

The World Bank has cited that India needs to generate 8.1 million jobs, which going by the current scenario, looks rather challenging. The IMF, too, has stated that reforms to hiring and dismissal regulations would help incentivise job creation and absorb the country's large demographic dividend.

Chart: How do earnings and the valuations look?

(Source: NSE)

Corporate earnings haven't been very encouraging; the Nifty 500 profit-to-GDP ratio is at a 15-year low. Plus, there are governance issues with a few companies.

Sadly, the oldest trick in the book of 'estimating earnings' played out is that the near term estimates are being toned down, while the future earnings estimates are being amplified. For several years, the market has initially projected 15-20% growth in earnings, but the actual growth has turned out to be very poor.

So, it is pointless getting swayed by the forward statements in the earnings.  If the economic growth does not pick up from here on, it may hurt the bottom line of companies. The impact of corporate earnings on your mutual fund portfolio would be hinged on the portfolio characteristics of the schemes you hold in your portfolio.

Hence, make sure you hold worthy mutual fund schemes and set realistic post-tax return expectations.

The trailing P/E of the Nifty 50 index has shot up to nearly 29x, while, that of the Nifty MidCap 100 index has seen a sharp drop since its September high and is now hovering at around 32x. Calling these levels cheap would be an imprudent judgement. That said, there is a scope to create wealth in the long-term with equity mutual funds if you strategically structure your mutual fund portfolio.

How to build a strategic portfolio?

To build a strategic portfolio of mutual funds, here are a few set of rules:

  • The selected mutual fund schemes should be amongst the top scorers in their respective categories. The portfolio should be built with a time horizon of at least five years.

  • It should be diversified across investment styles and fund managements.

  • Each mutual fund scheme should be true to its investment style and mandate.

  • The mutual fund schemes should be managed by experienced and competent fund managers and belong to fund houses that have well-defined investment systems and processes in place.

  • Each fund should have seen outperformance over at least three market cycles.

  • The portfolio should contain an adequate number of schemes in the right proportion. In short, it should carry the most optimum allocation to each scheme and investment style.

  • The number of schemes in your portfolio must be limited to seven.

  • Not more than five mutual fund schemes should be managed by the same fund manager.

  • Not more than two mutual fund schemes from the same fund house should be included in the portfolio

And most importantly it should be based on "Core & Satellite" approach to investing.

What is Core & Satellite Approach?

The 'Core and Satellite' approach is a time-tested investment strategy followed by some of the most successful investors to build a portfolio.

The term 'Core' applies to more stable, long-term holdings of the portfolio, while the term 'Satellite' applies to the strategic portion that would help push up the overall returns of the portfolio, across market conditions. Plus, the 'Satellite' portfolio provides the opportunity to support the 'Core' by taking active calls based on extensive research.

So, in mutual fund parlance, your 'Core' portfolio should consist of a large-cap fund, multi-cap fund and value style fund. Whereas, the 'Satellite' part of the portfolio --a smaller portion -- should include a mid-cap fund, large & mid-cap fund and an aggressive hybrid fund.

PersonalFN believes the 'Core' holdings should form 60% of your mutual fund portfolio and the rest 40% should consist of 'Satellite' holdings.

In an overvalued equity market such as the one we are witnessing, you cannot go all out and invest in mid-and small-caps or invest in an ad hoc manner based on what your friends and family say. You will most likely end up burning your fingers.

[Read: Why Mimicking Your Friend's Investments Can Be Risky]

What you need is Strategic Portfolio which is well-structured by assigning weights to each category of mutual funds so that you can clock optimal risk-adjusted returns.

Here are 6 benefits of 'Core & Satellite Approach':

  • Facilitates optimal diversification;

  • Reduces the need for constant churning of your entire portfolio;

  • Reduces the risk to your portfolio;

  • Enables you to benefit from a variety of investment strategies;

  • Aims to create wealth cushioning the downside; and

  • Offers the potential to outperform the market

Moreover, with the change in market outlook, the allocation/weight to each type of fund needs to be revisited, especially in 'Satellite' holdings. Unless that is done clocking superior inflation-beating returns over the long-term would not be possible.

While there is a sense of optimism about India's future growth, there are headwinds in play as well. For the market to move higher, the positives need to outweigh the negatives. That being said, the long-term outlook for India is not gloomy. In fact, there is hope and optimism -- irrespective of which political party forms government at the centre in 2019.

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The equity mutual funds recommended in this mutual fund research service have the ability to generate lucrative returns over the next 5 to 6 years.  Based on an extremely special theory, this portfolio is strategically designed to reap the benefits of two worlds, viz. short-term high-rewarding opportunities and long-term growth. Subscribe now!



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