Investments must be justified

PORTFOLIO MAKEOVER

I am 74 and retired. I have been investing in mutual funds for the past three to four years. I have sufficient investments in fixed deposits, bonds and senior citizen saving schemes to take care of my monthly income. Please review my portfolio to improve its quality.

"" Anonymous

A look at your portfolio makes one wonder if there is a strategy to your fund accumulation. There are two reasons why we feel this way. The first being that you have 33 funds in your portfolio and the second being your tendency to gravitate towards new fund offers.

The basic premise of a mutual fund is that it enables you to achieve diversification. Spreading your investments among five to eight mutual funds will definitely give you a flavour of various investment styles and risk appetites. But owning 33 funds will not lead to an effective de-risking of your portfolio. In fact, with these many funds, there are bound to be laggards.

We also notice a tendency to invest in new fund offers without assessing the impact of such investments on the entire portfolio. Whenever you shortlist a fund you must be able to justify its selection.

Question yourself before you put down any money: Is the objective of the fund such that it will deliver above average returns? Does this particular fund fill a lacuna in my portfolio? Do I have other funds managed by the same fund manager?

Take, for instance, your investment in a close-ended fund such as Franklin Templeton Smaller Companies. When you have experienced superior returns from investments in funds like Sundaram BNP Paribas Select Midcap and Reliance Growth why would you chase an untested fund?

Putting you on track
While fine tuning your portfolio, we deployed various steps.

The first was to tackle the rated funds. Six two- and three-star rated funds were eliminated from the portfolio.

The next task was to assess the unrated funds on the basis of their performance. That eliminated another seven.

The final step was to reallocate the balance holdings. The small holdings in generic equity diversified funds were shifted to your larger holdings. When doing so, we ensured that your exposure across different fund houses remains balanced. For instance, we did not want you ending up with 50 per cent of your portfolio in one fund house.

You will notice that we increased allocation to HDFC Prudence. We felt an exposure to a balanced fund is wise. This fund has displayed an uncanny ability to produce returns compared to a diversified equity fund with less volatility.

At the end of this exercise, we trimmed your portfolio to 18 funds.

What to look out for
When you implement the suggestions we recommend, take cognizance of the costs. You will have to bear with entry and exit (close ended funds) loads in such restructuring.

For investments that you have held for more than a year, you will not have any tax liability. But you will have to incur capital gains tax on selling the news ones like DSPML Small and Midcap. We suggest you hold on to this fund till October 2007 before redeeming it.

On a closing note, we have a suggestion concerning asset allocation. Since you do not depend on your mutual funds to generate a monthly income, we would like to suggest gold exchange traded funds (ETFs) for you.

A gold ETF will be a buffer to your portfolio during bear phases and will reduces volatility in returns. Moreover the price movement of gold is largely unrelated to the movement in equity market. The only drawback here is the absence of a dividend option.