I am interested in equity mutual funds, but I am scared of the risks involved. I have heard that shares of top FMCG companies like Hindustan Lever and ITC are stable. Would an FMCG fund be suitable?

- Supriya Sen

Greed, fear and hope are key drivers of stock markets. In your case, fear seems to be the pre-dominant emotion. And judging by the volatility of stock markets, your concerns aren't misplaced. However, FMCG funds may not be your road to El Dorado. 

The FMCG fund category has just three funds. All the three seem to be on the road to nowhere as far as returns are concerned. It is not the quality of management, but rather the type of stocks these funds invest in, that constrain their performance. 

FMCG stocks are said to be defensive in nature because in a falling market, their prices do not dip as much as the market. Conversely, prices do not move up much in a rising market.

This has put brakes on the returns of these funds. In the past year, the best performing FMCG fund posted a return of 25.73 per cent, compared to the diversified equity funds category average returns of 30.75 per cent.

As these funds have a mandate to invest in the FMCG sector only, they can't look for other opportunities. If the FMCG sector is not performing well, this will reflect in the funds' performance. As far as risk goes, they are riskier than diversified funds as investing in a sector fund amounts to placing all your eggs in one basket. If you wish to reduce the risk, balanced funds could be an option.

These funds invest in equity and debt in a particular ratio. While the debt portion provides stability to the portfolio, equities serve to boost returns. The past record of balanced funds is again much better than that of FMCG funds.

I have invested in a few equity funds with a target of earning at least 15 per cent returns. Should I redeem after 15 per cent returns or should I redeem only the profit and remain invested? What course of action would you recommend?

- Manish Patel

Your question about whether to hold on even after your target has been achieved seems to indicate that you desire even higher returns. There exists three possibilities. Either the markets will move higher and you will get even better returns, or they will decline and your profits will diminish. The third option is that they may remain range-bound. Knowing with certainty which option will take place is not possible.

The macro aggregates, however, point towards an optimistic future with the economy likely to grow at 9 per cent per annum. But giving a time and value to the market simultaneously is only guesswork. When a batsman goes out to bat, he will bat differently in a test match compared to a one-day game.

Similarly, you have to decide whether you are investing for quick profits or long-term returns. You need to decide whether you want an absolute profit of 15 per cent or a compounded return of 15 per cent over the long-term, say 10 years.

If you have a plan in place, such as going on a vacation and using your profits, it will help to be disciplined in booking profits. The more important thing than getting returns or higher returns is meeting your goals.

If these are achieved, then the purpose of investing is met. Always remember that in the midst of all the uncertainty, volatility and unpredictability in the markets, discipline is the most important virtue.

Would it not be better to take 85 per cent exposure to an income fund and 15 per cent to a pure equity fund rather than investing the whole amount in a monthly income plan?

 - Rajiv Krishnan

There are several dimensions to this riddle. If we look at this from the point of view of returns, then this combination or for that matter any combination of a good equity fund with a debt fund should generate better returns than a monthly income plan.

The most probable reason for this is that the equity component of an MIP is generally used to enhance returns and is managed with a lower return expectation than a pure equity fund. Conversely, this engineered combination could also take a greater hit in bad times.

If we look at such an engineered combination from the tax viewpoint, the portfolio re-balancing will be far less efficient than an MIP. An MIP by virtue of being a mutual fund, is not subject to capital gains tax on the buying and selling of its securities.

When you try to rebalance the engineered combination it will be subject to capital gains tax. This can eat substantially into the extra returns that the engineered combination would generate.

Being the fund manager of this monthly income plan, you will have to monitor it from time to time to take a decision to rebalance. Even if you mechanically rebalance at some fixed time period, this will require an effort on your part.

One of the least mentioned benefits of mutual funds is convenience and in the attempt to generate better returns, you would miss out on this. At the end of the day, if you desire higher returns, increasing the equity allocation in your portfolio could be a more convenient and practical approach. Otherwise an MIP does a fine job of boosting returns from a pure debt portfolio.