The ability of equities to deliver over longer time frames and even outperform other investment avenues like gold, property and bonds is an often chronicled fact.

However, over shorter time frames, equities also hold the potential to be a very risky asset class and expose the portfolio to high levels of volatility. This is the primary reason why any fund manager worth his salt always recommends a sufficiently long (at least 3 years) time frame for an equity-oriented investment.

Similarly financial planners advocate pruning of the equity holdings with advancement in the investor's age, when the investor is typically closer to retirement (shorter investment horizon) and has a lower risk appetite as well.

Personalfn's team of financial planners was recently approached by a retired gentleman in his sixties. His portfolio was populated with mutual funds, notably the equity-oriented ones, i.e. diversified equity funds and balanced funds.

The individual did not depend completely on these investments to take care of his monthly needs. The task on hand was to conduct a portfolio review and to incorporate necessary changes so that the portfolio would be geared to match the investor's risk profile.

A closer look at the investor's portfolio should help us better understand the case.

The facts

1. The total equity holding in the portfolio was around 86%. For an investor in his late sixties, such a high equity allocation was certainly uncalled for. In fact, it was the right time to start making a transition towards a more balanced (read 50:50) equity-debt allocation or thereabouts.

2. The composition of the portfolio was as follows - equity funds (71%) occupied a lion's share of the portfolio, followed by balanced funds (19%). Some of the balanced funds were of the aggressive variety with equity holdings in the 70%-75% range. Monthly income plans (MIPs) accounted for 6% of the portfolio; the average equity holding therein was around 20%. Fixed maturity plans (FMPs) and floating rate funds (2% each) completed the portfolio.

The portfolio reallocation process would work at two levels. Firstly, the portfolio had to be "relieved" of some equity funds and the debt component therein enhanced; adding MIPs would help us achieve the same.

Secondly, there was a dire need to de-risk the portfolio. Some of the schemes in the portfolio were aggressively managed high risk ones i.e. sector-specific funds and thematic funds, which were clearly unsuitable for the investor.

These had to be done away with and replaced by some conservatively managed funds. Effectively, the portfolio's risk profile would be trimmed and be aligned with that of the investor.

Given that interest rates are still on the rise, this was not the right time to make a radical change and introduce a higher debt component immediately. Hence, we proposed to conduct the exercise in a phased manner over the next one to two years.

The reallocation process

1. We started the exercise by targeting the most aggressive equity funds. These included some sector-specific and thematic funds that were in any case adding little value to the investor's portfolio.

2. Then we axed some of the new fund offers (NFOs), which the investor had been "conned" into investing by his earlier investment advisor. These NFOs were non-performers to put it politely and had no place in the portfolio. Fortunately for the investor, the rising markets meant that he could redeem these investments at a profit.

3. Finally we shifted our focus to a balanced fund in the portfolio. With the promise of capitalising on opportunities in the derivatives segment, this fund was a "perfect" misfit in a long-term investor's portfolio.

The action points

1. Of the surplus generated, we recommended that the investor should allocate a substantial portion (50%) to MIPs.

2. Similarly, we recommended that the investor park a portion of the surplus generated in short-term debt/liquid funds. A systematic transfer plan (STP) could be initiated from the same into our recommended diversified equity and balanced funds. Balanced funds would account for 30% of the surplus generated.

3. 15% of the surplus was set aside for investments in conservatively managed value style diversified equity funds.

4. The balance (5%) would be maintained in liquid form for investing in attractive FMPs as and when the opportunity presents itself. Given their fixed tenure and "predictable" returns, FMPs can be strategically used for generating cash flows at regular time intervals.

Of the new investment made as a result of liquidating the equity-oriented funds, only about 45% made it back into equities; in other words if Rs 100 were realised from liquidation, only Rs 45 was reinvested in equity (in value style equity funds) and the balance (Rs 55) in debt.

As a result of the above, the debt component in the portfolio went up from 14% to 46%, while the equity portfolio stood trimmed from 86% to 54%. Also it should be understood, that this is only the first step in the reallocation exercise. The process will continue to be conducted in a phased manner until the desirable equity-debt mix is achieved.

At Personalfn, we have always laid emphasis on the need to regularly monitor the portfolio and modify the same in line with the investor's changing risk profile and financial goals. The above case study demonstrates how even a well-made portfolio can go awry with passage of time.

Monitoring and modifying a portfolio necessitates the services of a qualified and competent investment advisor. Our advice -- ensure that your advisor is up to the task.

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