Mutual funds have surely come a long way in India. More and more investors are including them in their portfolio. Even the mutual fund industry has responded very well to the changing needs of investors as well as the need to segment the marketplace by offering a wide variety of products.

Though there is a marked change in the quality of advice being given to investors, it is still a challenging task for investors to get the best from mutual funds. Investors need to have proper understanding and skill both in terms of selection of funds as well as monitoring their progress.

Let us discuss some of the situations that many investors face from time to time and also the right way to tackle them:

Negative returns from the funds

Many investors equate negative returns with the poor performance. However, the fact is that negative returns from a fund do not necessarily mean poor performance. Even the best of fund mangers are likely to give negative returns during periods where markets go down significantly.

Besides, the time period considered also signifies the true level of performance. For example, short-term negative returns, in line with the market, from a fund that has been doing well for years means nothing and should be ignored.

Similarly, even a bad fund manager can give decent returns when the markets are doing well. Besides, a fund manager can enhance the returns of a fund in a good market by increasing the risk exposure. Therefore, one needs to go beyond the short-term performance numbers and analyze the performance of the peer group to judge the skill of a fund manager.

Growth or Value investing

Apart from offering variety of products, fund managers also follow different investment strategies. The most prominent ones are 'Growth' and 'Value' investing strategies. This often confuses investors and hence they end up investing in a fund whose strategy may not suit their requirements.

The fund manager of a fund that follows 'Growth' style focuses on the expected ability of a company to grow its earnings at an above average rate. In other words, key areas are strong earnings of the company, evidence of market leadership as well as the signs that the growth would not only continue but also accelerate over time.

A 'Value' fund on the other hand, emphasizes companies below their perceived potential value. In other words, value fund manager invests in out of favour companies with the expectation that their stock prices will eventually rise to reflect the company's true value.

Why do fund managers keep cash in the portfolio?

Investors often wonder as to why fund managers keep cash in the portfolio.  It is important to know that fund managers generally keep cash in hand to take care of redemptions. Besides, as the money comes in from new investors or dividends, it accumulates in cash before it can be invested. In other words, a fund manager keeps cash in hand not to benefit investors but to facilitate the management of fund.

While there is no hard and fast rule with regard to the level of cash as a percentage to the overall portfolio size, most funds, in normal circumstances keep it up to 5 percent. However, there can be occasions wherein the fund manager may keep cash at much higher level.

This could be for various reasons such as cash generated by selling of securities to book profits, volatile markets may force the fund manager to wait for the market to settle before investing or huge inflows over a certain period of time.

If I need money, should I sell funds that are performing well or the ones that are not doing well?

This is a dilemma that investors face many a times. However, a common mistake that investors make is that while selling, they follow a different strategy from what they do at the time of making an investment. In other words, while selling they do not give due regard to past performance the way they do while investing.

There is generally a tendency to hold on to non-performing funds and sell better performing schemes too soon. If a particular fund is not keeping pace with the rest of funds in the same category, it makes sense to exit from that. However, before making a decision to sell on the basis of poor performance, it is necessary to put performance in perspective. In other words, you need to consider relative performance and not absolute performance alone.

What is the significance of the market cap in scheme selection?

 A common mistake made by investors is to follow a hodgepodge strategy while investing in mutual funds. In other words, proper attention is not paid to having the right exposure to different market caps. Market cap of a company signifies its market value, which is equal to the total number of shares outstanding multiplied by the current stock price.

The market cap has a role to play in the kind of returns the stock might deliver and the riskiness or volatility that may have to encounter from the stock. For example, large companies are usually more stable during the turbulent periods and the mid cap and small cap companies are more vulnerable.

There cannot be a standard combination applicable to all kinds of investors. Each one of us has different risk profile, time horizon and investment objectives. Besides, while deciding on the allocation, one has to keep in mind the fact whether the allocation is being done for an existing investor or for a new investor.

While for an existing investor, the allocation that already exists has to be considered, for a new investor the right way to begin is consider well diversified funds that invest predominantly in large cap stock and have small presence in mid and small cap stocks. Another important factor is the current state of the market as well as how the market is expected to behave in say next 6 to 12 months.

The author is CEO, Wiseinvest Advisors Pvt. Ltd. He can be reached at hemant.rustagi@moneycontrol.com

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