mutual fund portfolio: 7-point checklist for your mutual fund portfolio

A new year can be the perfect time to review and reflect on your investment portfolio. Here’s a simple 7-point checklist you can use to assess your investments and refine your strategy.

Do you have an emergency fund to help you through difficult situations?

The recent covid crisis is a good reminder of the importance of an emergency fund. Salary cuts, job losses, medical bills, etc. can come out of nowhere. Be sure to maintain at least 6-12 months of your monthly expenses in a secured debt fund or fixed deposit.

Is your current asset allocation in line with your original plan?

Given the recent rally in the stock market, chances are your equity allocation will be much higher than your originally planned asset allocation. If your equity allocation exceeds your original asset allocation by more than 5%, now is a good time to take profits and realign them with the original allocation.

For example, suppose you have a long-term asset allocation of 70% in stocks and 30% in debt. Right now, say, if the asset allocation has drifted to 77% in stocks and 23% in debt, it’s a good time to sell some stocks (i.e. 7% of the portfolio total) and move on to debt. This will bring the allocation back to the original planned allocation of 70% equity and 30% debt.

Is your stock portfolio sufficiently diversified between different investment styles?

The last few years have favored the quality style and global equities (US in particular). Chances are you’ll be over-allocated to equity products of these investment styles if you rely solely on past returns.

If so, you can diversify equally between 5 different investment styles – Quality, Value/Contrarian, Growth at a Reasonable Price, Mid & Small Cap, Global Equities to create a well-diversified equity portfolio with a low portfolio overlap. This will ensure reasonable long-term returns with lower volatility.

Does your portion of debt carry interest rate risk and credit risk?

Duration risk and credit risk are legitimate ways for debt funds to increase their returns. However, they also carry risks. Credit risk funds present two major risks. First, credit risk: the risk of a decline in net asset value if the underlying bonds default or are downgraded. Second, liquidity risk: since lower credit quality papers cannot be sold easily in the Indian bond markets, unexpected redemption pressures from investors may lead to the closure (recall the closure of 6 funds of credit risk-oriented debt by Franklin Templeton) or a sharp decline in net asset value due to distress selling.

Funds with longer durations are subject to interest rate risk – the risk of a greater decline in net asset value if interest rates rise. This requires more attention now, as we expect interest rates to gradually rise in the future. Since most of us view debt funds as an alternative to term deposits, the majority of your debt exposure should be in funds with short durations (less than one year to reduce interest rate risk). interest rate) and high credit quality (> 95% AAA and equivalent exposure to avoid credit risk).

Even if you want to take interest rate risk or credit risk to enhance returns, it is best to limit these risks to less than 30% of your overall debt exposure.

Do you have the right return and volatility expectations?

  • Debt funds and FD – Lower your return expectations As interest rates are low relative to the past, your return expectations for debt funds and term deposits should be well below what you have enjoyed over the 3-to-3 period. 5 years before covid. For debt funds, return expectations should center on the current YTM adjusted for the expense ratio. YTM stands for Yield To Maturity and you can basically think of it as the weighted aggregate interest rate paid by the underlying bonds in your debt fund.
  • Equity – Earnings growth to drive returns In equity markets, given the current high valuations, returns over the next 3-5 years will need to be driven primarily by earnings growth. The potential to increase valuations and contribute to returns is very low. While the past 5 years have seen paltry earnings growth, it is reasonable to expect above average earnings growth over the next 5 years. This expectation is driven by various drivers of earnings growth such as strong growth in the technology sector, wage increases, recovery in manufacturing, banks – improving asset quality and gradual recovery in loan growth, the revival of the real estate sector, the government’s heavy focus on infrastructure spending, early signs of business investment, low interest rates, favorable global growth environment, consolidation of market share by market leaders, strong corporate balance sheets thanks to deleveraging and government reforms (corporate tax cuts, labor reforms, PLI), etc. a strong acceleration in earnings growth is already visible. The spread of the new Covid variant, global inflation and Central Bank actions remain the main near-term risks. On the volatility side, although it is impossible to predict but based on past history, a temporary correction of 10-20% every year is almost a given and should be considered normal stock market behavior if it happens. If the markets fall more than this, it may be a good opportunity to increase the equity allocation.

If the markets fall, do you have a “CRISIS” plan?

Instead of making investment decisions in the middle of a market drop, a preloaded decision plan (If-Then model) is a good way to approach a major market drop. Decide in advance that part of your debt allocation will be deployed in equities if, in the event of a market correction –

  1. If stock markets fall about 20%, move x% of the share from pre-determined debt to equities
  2. If stock markets fall about 30%, move y% of the pre-determined debt portion to stocks
  3. If stock markets fall about 40%, move z% of the share from pre-determined debt to equities
  4. If the stock markets fall by around 50%, move the remaining amount of the pre-determined debt portion into stocks
  • Percentages can be decided based on your individual preferences and risk appetite.

Have you increased your SIP amount?

Investing more each year as your salary increases is good practice. Check if you have increased your SIP amount. If not, this may be a good time to increase it.

While not an exhaustive list, the 7 checks above can ensure your portfolio is well prepared to handle whatever 2022 has in store for us all.

The author is the Head of Research, FundsIndia.)

Dolores W. Simon