The ‘Core And Satellite’ Approach
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In January 2010, I had invested in the following funds: ING Mid-Cap, Birla Dividend Yield, ICICI Pru Discovery and Sundaram S.M.I.L.E. Please analyse my equity portfolio and suggest funds which will generate high returns over the next few years.
- Rajshekar Srinivas
Your portfolio is quite aggressive, as all your investments are in Small- and Mid-Cap funds. This strategy may be quite risky, as these funds invest in stocks which can be very volatile.
As the graph shows, the S&P BSE Mid-Cap and the S&P BSE Small-Cap indices have significantly underperformed the S&P BSE Sensex in falling markets. For example, in 2008, when the global markets crashed, the Sensex fell by 52 per cent, while the Mid-Cap and Small-Cap indices fell by 67 per cent and 73 per cent respectively. The same phenomenon occurred in 2011 – the Sensex had declined by 25 per cent, while the Mid-Cap Index went down by 35 per cent and the Small-Cap index was down by 44 per cent.
While a small allocation to Small- and Mid-Cap funds can enhance returns, you should have the majority of your equity portfolio invested in Large-Cap or Multi-Cap diversified funds. Large-Cap funds generally invest in ‘blue chip’ stocks of well-established companies with strong financials and steady growth prospects. Multi-Cap funds invest in a mix of Large-Cap and Small and Mid-Cap stocks. These funds are relatively safer than Small and Mid-Cap funds.
Large-Cap oriented funds are generally more consistent than Small- and Mid-Cap funds and have lower downside risks (DSR), as shown in the table. The returns from these funds may fluctuate more than those from Large- and Multi-Cap funds, especially when the markets are turbulent.
| Scheme Performance As On February 26, 2012 |
|---|
| Scheme Name | 1-Year | 3-Years | 5-Years | 1-Year | 3-Years | 5-Years |
|---|
| CAGR | DSR |
|---|
| Large-Cap Funds |
| Birla SL Frontline Equity Fund(G) | 14.31 | 8.01 | 6.88 | 2.54 | 6.78 | 12.18 |
| Franklin India Bluechip Fund(G) | 7 | 8.15 | 7.04 | 2.42 | 5.88 | 11.55 |
| FT India Dynamic PE Ratio FOFs(G) | 7.56 | 7.67 | 8.08 | 1.44 | 2.88 | 7.39 |
| HDFC Top 200 Fund(G) | 6.38 | 7.59 | 7.83 | 3.05 | 6.99 | 12.19 |
| ICICI Pru Focused Blue Chip Equity Fund-Reg(G) | 8.8 | 10.73 | - | 2.57 | 6.64 | - |
| ICICI Pru Top 100 Fund-Reg(G) | 8.56 | 8.58 | 5.47 | 2.55 | 6.87 | 12.41 |
| Multi-Cap Funds |
| Franklin India Prima Plus Fund(G) | 10.7 | 8.99 | 6.21 | 2.34 | 6.16 | 11.34 |
| HDFC Equity Fund(G) | 6.27 | 7.59 | 8.27 | 3.08 | 7.07 | 12.55 |
| ICICI Pru Dynamic Plan-Reg(G) | 6.84 | 7.94 | 7.44 | 2.17 | 6.02 | 12.18 |
| UTI Dividend Yield Fund(G) | 3.54 | 7.44 | 8.39 | 2.55 | 5.8 | 10.03 |
As a general guideline, you should reduce your Small- and Mid-Cap exposure to about 20-25 per cent of your overall equity portfolio. You could exit ING Mid-Cap and Sundaram S.M.I.L.E. since these funds have underperformed their peer-group. Not only did these funds have higher downside risks than the other Small- and Mid-Cap funds, but they also failed to generate high returns. You could redeem your investment in the two funds and invest in some of the Large- and Multi-Cap funds shown in the table. These funds have generated high risk-adjusted returns and are among the top performers in their categories.
| Scheme Performance As On February 26, 2012 |
|---|
| Scheme Name | 1-Year | 3-Years | 5-Years | 1-Year | 3-Years | 5-Years |
|---|
| CAGR | DSR |
|---|
| Small & Mid-Cap Funds |
| Birla SL Dividend Yield Plus(G) | 4.53 | 8.98 | 11.18 | 2.57 | 5.94 | 10.2 |
| HDFC Mid-Cap Opportunities Fund(G) | 9.61 | 12.74 | 9.69 | 2.28 | 6.02 | 11.86 |
| ICICI Pru Discovery Fund-Reg(G) | 14.75 | 10.31 | 12.59 | 2.23 | 6.59 | 13.69 |
| IDFC Premier Equity Fund-Reg(G) | 15.61 | 12.82 | 10.08 | 1.92 | 5.82 | 12.07 |
| IDFC Sterling Equity Fund-Reg(G) | 16.61 | 10.9 | - | 2.33 | 6.64 | - |
| ING Midcap Fund(G) | 5.56 | 5.92 | 0.67 | 3.35 | 7.12 | 15.04 |
| Sundaram S.M.I.L.E Fund(G) | 3.4 | 0.26 | 2.06 | 3.63 | 9.01 | 15.08 |
You could retain your investment in BSL Dividend Yield, as this is a relatively conservative Small- and Mid-Cap fund. BSL Dividend Yield invests in companies with high dividend yields, which typically have strong cash flows, healthy balance sheets and stable growth rates. You can also hold on to ICICI Pru Discovery. On a risk-adjusted return basis, this fund has consistently been in the top quartile.
To sum up, you could follow the ‘core and satellite’ approach. Large- and Multi-Cap funds should form the bulk of your portfolio (the ‘core’), while a small portion can be invested in Small- and Mid-Cap funds for higher returns (the ‘satellite’). Rebalance your portfolio to reduce your Small- and Mid-Cap exposure. Your allocation to Small- and Mid-Cap funds should ideally be governed by your risk tolerance and investment horizon – a financial advisor can help you determine this. Through this approach, you will be able to reduce the downside risk of your overall portfolio, while maximising returns.