Reduce exposure to high-beta funds amid choppier conditions: Experts

On February 24, the Sensex declined 4.7 per cent as news came in of Russia’s invasion of Ukraine. Equity mutual funds’ trailing returns ranged between minus 7.2 per cent and 3 per cent on that day. Their one-month return ranged between minus 10.4 per cent and minus 2.1 per cent.

If your funds’ decline on that day left you unnerved, you need to re-examine your holdings. First, try to understand the source of underperformance. Then, cull out funds that are too risky.

Check market-segment exposure    

Are the funds you are holding large-, mid- or small-cap oriented? The latter two will take a bigger hit in volatile market conditions.

“These funds outperform heavily during market rallies, but they also underperform during downturns,” says Deepesh Raghaw, founder, PersonalFinancePlan, a Securities and Exchange Board of India-registered investment advisor. Their underperformance can sometimes last for two-three years. A fund that is value-oriented may have a large tilt towards mid- and small-cap stocks, in which case it will be more volatile.    

What is your fund style?

Your fund manager may be following a growth, value or blended style. Growth and momentum styles tend to outperform in rising markets. Also, bear in mind that an investment style that has done well in the past does not always continue to do so, which makes it incumbent to be diversified across styles.  

Excessively concentrated?

Funds that run more concentrated portfolios tend to be more volatile.

“A focused fund usually has around 25 stocks in its portfolio. Its top five or 10 holdings will occupy a larger portion of the portfolio than in a diversified fund. Hence, the fund could be more volatile,” says Arnav Pandya, founder, Moneyeduschool.

Also check your fund’s sectoral exposure.

“Some fund managers take more concentrated bets on certain sectors. Their funds will tend to outperform by a bigger margin if these bets pay off, and vice versa,” says Pandya.  

Also see if your fund allocates heavily to cash. A fund that takes large cash calls may decline less during market downturns. But it could be left on the sidelines when markets start rallying.  

  

Too small a corpus?  

Sometimes, assets under management can affect performance. “In a very small-sized fund, even small outflows can force the fund manager to sell some of his core holdings, which could be detrimental to performance,” says Pandya.

Diversify across asset management companies

Sometimes, funds from the same fund house may be top performers in various categories. Investors may flock to those funds. But these funds may hold the same stocks or have a common fund management approach. When the tide turns, the very strategy or picks that had catapulted these funds to the top of the table, could pull them down. Diversify across fund houses.

Follow core and satellite approach

Follow a core and satellite portfolio approach. In the core portfolio, hold stable and diversified funds that give market-equivalent returns. These could be a Nifty50 index fund and an S&P 500 fund. The core portfolio should constitute the bulk of your portfolio.  

In the satellite portfolio, take exposure to funds that can generate alpha. Hold mid-cap, small-cap, and thematic funds here.

However, limit exposure to these high-beta funds.

“Limit exposure to mid-cap funds to 20-25 per cent of your equity portfolio and to small-cap funds to 20 per cent or less. Exposure to a single sector or thematic fund should not exceed 5 per cent of the equity portfolio. Exposure to sector or thematic funds altogether should not exceed 10 per cent,” says Kaustubh Belapurkar, director-manager research, Morningstar Investment Adviser India.

Maintain international diversification. Finally, as Belapurkar suggests, in long-term portfolios, start reducing exposure to equities around three-four years prior to the goal, so that a sudden market downturn doesn’t jeopardise its achievement.