Mid-cap funds should form a smaller part of your portfolio

FUND QUERIES

Are mid-cap funds, such as Birla Midcap and Sundaram Select Midcap, an attractive investment option? -S. Roy

Mid-caps are generally more volatile and relatively less liquid than large-caps. This makes funds investing in mid-caps more volatile compared to their large cap peers. During an economic recovery, smaller companies usually have a bigger bounce than larger ones, because they are working off a relatively smaller base.

But this does not mean that every mid-cap stock will do well. Such companies also involve greater risks, such as limited product lines, a smaller market and lower financial or managerial resources. Stock selection is thus critical to managing a mid-cap fund.

Birla Midcap and Sundaram BNP Paribas Select Midcap are old funds with a good performance track record. More importantly, these funds have managed to keep volatility of returns low relative to their peer group.

While mid-cap stocks have indeed rallied, it is difficult to take a call on their future direction. The continued economic progress could brighten their chances further, and catapult them into the large-cap space. As mid-cap funds focus exclusively on a particular category of stocks, they should form a smaller part of the portfolio - say up to 20 per cent.

My mother invested Rs 3 lakh in bank fixed deposits. She would like to move this amount to an income fund to avail of better returns. Should she reallocate it at one go in one single fund or different funds over time? -Praveen Joshi

It is a good thing that as a fixed-income investor your mother has started looking beyond bank fixed deposits. While most banks have upped the interest rates on fixed deposits, income funds have had to deal with volatility in returns. They have delivered a decent 5-7 per cent return in the last one year. This is at a time when fixed deposits are earning rates as high as 8-9 per cent.

Do keep in mind that the high FD rates will over time see a downward revision. As far as the details of investing go, the golden rule, as always, is not to put all your eggs in one basket. Not only must you spread your investment among funds that follow a different approach, but you could even retain a certain amount in the FDs.

Income funds score over FDs chiefly on the issue of liquidity, ease of investing and tax-efficiency. Funds are easy to get into and out of. Interest from FDs is added to your overall income and you will be taxed according to the bracket you fall under.

Debt funds on the other hand attract a long term capital gains tax of 20 per cent with indexation, or 10 per cent without, which ever is lower. So do go in for the growth option. Indexation is the process by which inflation is taken into account when calculating your return.

As to the investment pattern, it is best to fine-tune that to your mothers' likely investment and redemption needs. If she is still earning, you could transfer most of the money to income funds and then perhaps keep adding to it through a Systematic Investment Plan. Or, if she has already retired, you could invest in one go and then add a Systematic Withdrawal Plan if she needs to use the income for any regular purpose.

Securing child's future
I have invested Rs 50,000 in two mutual fund schemes for children. Could you tell me more about such schemes? -Ashok Singh

Your financial goals may be specific - investing for your child's education or marriage. But the investment avenue need not be so.

Children's benefit funds - as they are usually called - have a hybrid character with different equity-debt allocation. For instance, HDFC Children's Gift Fund has both a Savings Plan (which invests primarily in debt) and an Investment Plan (where the equity allocation can touch as high as 60%). This balanced character helps in growth of investments with low volatility. That is because unlike pure equity funds where wild swings may cause palpitations, a debt allocation in a hybrid fund, such as a children's fund, reduces volatility.

However, the suitability depends on the age of the child at the time of investment. If your child is, say, five years old, the investment time horizon could be about 10-12 years. If your child is a teenager, the investment horizon could be three-four years.

In the second case, knowing that the financial need is drawing to a close, you may not want to risk your investment by putting money in equities. In such a situation, any fixed income avenue like an income fund or a bank fixed deposit may serve your goal well. These funds will yield a slow and steady return.

The return on these funds varies from 1-28 per cent. The main drawback with these funds is that almost all of them levy a heavy exit load. This provides a disincentive for premature redemption of funds. However, if the fund's performance slackens, withdrawing money could attract a heavy penalty.

You could create your own customised child fund by investing in equities or an equity fund and a portion in fixed income. However, constant rebalancing could be quite a pain. We recommend an investment in a hybrid debt-oriented or equity-oriented scheme, depending on your risk profile. These funds will work just as well.