There are no two opinions on the fact that mutual funds are increasingly gaining widespread acceptability among masses. Investors who have traditionally embraced fixed deposits, post-office schemes and even stocks have bought the idea of investing through a professional money manager.

Now for some bad news. There are too many mutual funds in the country and investors aren't able to decide which fund to own and which to abandon. A steady stream of mutual fund IPOs compounds the issue even further.

We have tried to define an ideal mutual fund portfolio for the investor with a moderate risk appetite and an investment time frame of at least five years.

1. A large-cap diversified equity fund

One of the first funds that investors should probably consider owning is a large-cap diversified equity fund with a steady track record of at least five years. Large cap stocks would typically include stocks from the BSE Sensex/S&P Nifty.

• MF round-up: September 2004

A well-diversified fund should have not more than 40% of assets in the top 10 stocks (this is a global standard). A steady track record should involve outperformance vis-à-vis the benchmark index and peers especially during a downturn in equity markets.

Admittedly, there are few funds that fit the bill, but the ones that qualify are the ones worth owning.

2. A mid-cap diversified equity fund

Mid-cap funds (with the exception of Franklin Prima Fund) did not exist until even 3 years ago. So its a fairly nascent fund category. You can give the 'steady 5-year track record' criterion a miss for mid-cap funds.

However, you need to be careful of 'mid-cap funds' as right now its 'fashionable' to be invested in mid-cap stocks. There are a lot of 'opportunity' funds with equity portfolios that swing in line with the market mood. So if the accent is on large cap stocks the 'opportunity' fund will be invested in large caps.

If the mood in the markets turns and mid-cap stocks are pitch forked into the limelight, the fund's strategy will reflect the change in the market mood.

Choose funds that define themselves as 'mid-cap' either by name or by investment objective. Also look at the benchmark index; a fund that benchmarks itself against the CNX 500 or BSE 500 can be considered a mid-cap fund. However, a fund that tracks the Sensex or Nifty may not necessarily be a mid-cap fund even if it has a lot of mid-cap stocks in its current portfolio.

In other words, a fund's investment objective and investments should both correspond to its benchmark index.

3. A balanced fund

Balanced funds work particularly well during a downturn in equity markets, when the fund manager has a window to shift assets on to the debt side. The flexibility helps the fund manager curtail losses in a falling market.

While selecting a balanced fund, choose the conventional type - 60:40 (equity:debt) with a steady track record. Make sure the fund manager sticks to the 60:40 mandate even during bullish times, when most balanced fund managers succumb to the temptation of over-allocation to equities for higher growth.

4. A monthly income plan

A monthly income plan (MIP) works on the same premise as a balanced fund. The fund manager has the flexibility to invest a portion of assets (between 5-25% of assets in most cases) in equities.

An MIP works well when debt markets are witnessing a subdued phase, like now for instance. When debt markets are in turmoil, the fund manager has the flexibility to shift assets in equities (provided equity markets are robust) to generate that extra growth. Again, since MIPs are a relatively recent phenomenon, investors can consider the short-term performance (at least 1-year) before selecting a good MIP.

If you are looking for a regular income stream, choose the quarterly option as opposed to a monthly option, to allow the fund manager to declare a dividend in volatile equity markets.

5. A floating rate fund

Floating rate debt funds invest in floating rate paper. Floating rate instruments have their coupon rates adjusted at periodical intervals, which reduces price fluctuations arising out of interest rate volatility.

Investors can park funds in a floating rate fund (short-term plan) until more attractive investment opportunities emerge. Given the scenario in debt markets at present, we believe its makes more sense to own a floating rate fund for some time going forward, rather than a regular long-term debt fund.

Floating rate funds have a relatively short history and investors can look at the 1-year performance before selecting a floating rate fund.

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