9.

Scheme Selection
 Structured Approach

 First understand the risk exposure appropriate for an investor

through risk profiling.

 Structured Approach :

1. Deciding on scheme category.

2. Selecting a scheme within the category
3. Selecting the right option within the scheme.
 Risk Hierarchy
^^^^^ HIGH ^^^^
Debt Funds Hybrid Funds Equity Funds
Sector
Balanced funds based on
flexible allocation
Growth
High Yield Debt Funds
Diversified Equity
Index
Value
Equity income/ dividend yield
Balanced funds with fixed
allocation
Monthly Income plan
Capital protection oriented
scheme
Diversified Debt
Gilt
Money Market/ Liquid
,,,, LOW ,,,,
 Equity Funds (1)
 Principle to internalize : markets more predictable in the long run.

 Dangerous – less than 2 yeas, Ideal – 3 years.

 Chances of losing money is negligible for 5 years & above – at least
one opportunity will have to sell with attractive return.

 Active or Passive :
 Passive funds (index funds) – expected to offer return in line with
the market, NAV generally moves with index (no guarantee)
 Active Funds – higher risk, higher cost of management, should beat
the market, (no guarantee)

 Pension funds are limited by their charter to take exposure only

through index funds.
 Equity (2)
 Open-ended or close ended :

 Open ended :
 Offers liquidity (fund keeps a part of assets in liquid form – dilutes
returns in equity funds)
 Risk of large fluctuation in net assets – pressure on fund manager
 Exit load : Re-purchase can have exit load [SEBI prescribed
maximum of 7%; in practice it was rarely above 5%, which too was
applicable only if investor exits within a year ]

 Close ended :
 Provides liquidity through listing – units are not actively traded.
 Price tends to be lower than the NAV – only towards maturity price
converges with NAV.
 Equity (3)
 Diversified, Sector or thematic

 Diversified Fund :
 Less risky, as it provides multi-sector exposure.
 FM ensures higher exposure in better performing sectors.
 Should be a part of core portfolio of every investor.

 Sector /Thematic Funds :

 Investor is taking role of making a sector choice & should have the
skill
 At any point of time exposure to be limited to 3-5 sectors & more
than this means having diversified portfolio of sector funds (instead,
he can invest in diversified funds)
 Investors who can identify promising investment themes rather than
sectors can prefer Thematic funds.
 Equity (4)
 Large Cap V/s Mid/Small cap funds:

 Large Cap:
 When industrial scenario is difficult, large cap front line stocks
survive on account of resource strength.

 Mid/Small Cap:
 Economic turmoil, risky – many fall because of lack of resources.
 Recovery in economy - investors starts investing and valuation of
front line stock becomes expensive & mid/small cap funds provides
attractive opportunities.
 Long term – some of the mid/small cap companies will become
large cap companies, whose shares get re-rated & healthy returns
on such stocks can boost the returns.
 Equity (5)
 Growth or Value funds:
 Initial phase of bull run - growth funds offer good returns
 Over a period of time, growth shares get fully valued & value funds
performs better & value funds yield benefits in longer holdings
 Market correction: growth funds decline more than value funds.

 Fund Size :
 Size is to be seen in the context of proposed investment universe.
 Small size will not benefit from economies of scale.

 Portfolio Turnover Ratio:

 Calculated : Value of purchase and sales during a period divided by
the average size of the net assets.
 Frequent churning (high portfolio turnover) indicates unsteady
investment management & also adds cost.
 To be viewed in the light of investment style.
 Equity (6)
 Arbitrage funds:

 Not meant for equity exposure – but to lock into a better risk-return
relationship than liquid funds and to have tax benefits the equity
scheme offers.

 Domestic V/s International Equity Fund :

 Two exposure in investment abroad : in equities of international
market & Foreign Currency movements.

 Reasons for investing abroad :

Investor feels that overall return (equity + exchange rate) will be
attractive &
Asset allocation call for diversification of risk.
 Debt Funds (1)
 Regular Debt fund V/s MIP:
 MIP has an element of equity.
 Investors not willing to take exposure in equities, should prefer
Debt Fund
 Open Ended Fund V/s FMP
 Investors requiring funds any time would prefer normal open-
ended debt fund. FMP is ideal when investor’s time horizon is in
sync with the maturity.
 Gilt Fund Vs. Diversified Debt Fund:
 Diversified Debt Fund managing credit risks can offer superior
returns than Gilt funds.
 Long Tem Vs. Short Term Fund :
 NAVs of long term funds are more volatile .
 If expectation is rising interest rates, short term funds can be
preferred.
 Debt Funds (2)
 Money Market Fund Vs. Liquid Schemes:
 For retail investors, comparable rate to liquid scheme is SB rate &
switching SB balances to liquid schemes can improve the returns.
 CA holders can transfer surplus in liquid schemes.
 All money need not be kept in liquid scheme (can be in other
debt/equity schemes)
 [Liquid Plus are short term funds investing in securities longer than
that of liquid schemes to provide higher returns. To prevent potential
miss-selling, SEBI has disallowed the usage of “Liquid Plus”]

 Regular Debt Vs. Floaters:

 Floating rate securities tend to hold their value , even if interest rate
fluctuates.
 When interest rate scenario is unclear, floaters are safer option.
 In rising rate scenario, floaters are alternatives to short term debt and
liquid funds.
 Balanced Schemes
 Investors desirous of having debt & equity has two options:

 (1) Mix of equity & debt schemes

 More decisions on scheme selection
 Has wide options
 Can work towards appropriate mix of debt and equity

 (2) Balanced Fund scheme

 Simpler – fewer scheme selection decisions
 Has to go through mix of debt- equity
 Cautious on high risk potential, if structured as flexible asset allocation
schemes.

 Balanced Funds may be treated as debt funds depending upon the

portfolio
 Other Schemes
 Gold Funds:
 Differentiate between Gold ETF & Gold Sector Funds
 Performance of gold sector funds is linked to profitability & gold
reserves of these companies.
 Understand the structuring of the gold schemes.

 Other Funds:
 As per the regulations debt, equity, gold & real estate are only
asset class now permitted for investment.
 Selection of Scheme within Scheme Category (1)
 Investor buying into a scheme is buying into its portfolio
 Investors to be convinced that sectors/companies where scheme has
taken exposure.
 Large portion of fully value front line stocks in value funds indicates
that the FM is not true to investment style
 Debt investors to ensure that the weighted average maturity is in line
with their view on interest rates
 In non-gilt debt schemes, keep an eye on credit quality of portfolio and
watch out for sector concentration

 Fund Age :
 Fund age is important for equity scheme, because of more options &
divergence in performance of schemes in the same category tends to
be more.
 A new fund managed by a portfolio manager with lackluster track
record to be avoided
 Selection of Scheme within Scheme Category (2)
 Running Expenses :
 Cost is a drag on returns
 To be more careful about the cost structure of Debt Schemes
(because in the normal course, returns in debt can be lower than
equity)
 High cost in passive (Index) funds questionable.

 Tracking Error :
 Amongst the index schemes & Gold ETFs tracking error is the basis
for selection.
 Lower the tracking error, better is the scheme.
 Regular Income Yield in portfolio
 Schemes income comes from Dividend, interest and capital gains.
 Higher regular income yield is positive for the scheme.
 Risk, returns and risk adjusted returns are parameters to evaluate
schemes & forms the basis to assign ranking (by research agencies).

 Each agency has its distinctive methodology for ranking/rating –

(detailed in their website)
 Some research agencies follow a star system (5 star, 4 star etc. – 5
star is better than 4 star).
 It is not ideal for investors to switch every quarter, as the best
ranking fund in a quarter need not be the best in next quarter.
 Aim to stay invested in top “few” -(3 to 5 in category having a few
schemes & 10 to 15% for categories with more schemes).

 Remember – beyond performance, loads makes difference in returns.

 Better option within the scheme
 3 options : Dividend payout, Dividend re-investment & Growth

 Dividend payout is attractive for investors wanting regular income

 SWP is better to get regular income, since dividends will be
declared only if the fund has distributable surplus.
 In Debt scheme, dividend distribution tax is effectively paid by
the investor (as it reduces NAV)
 This cost may be fine to the investors in high tax brackets (impact
of this will be lesser than his marginal tax rate)

 Investors with lower tax rates (e.g.. pensioners) , dividend option

is not preferable and SWP can take care their regular income
need

 Taxation & liquidity needs are the factors in deciding between the
options.
 Source data to track performance
 Mutual Fund review is data intensive.

 Many AMCs, distribution houses, research houses offer free tools

to ascertain performances in the websites.
 Investors/distributors wishing to access the data (NAV, Dividends
etc.) and integrate into their investor-management systems can
subscribe the data from the vendors/download through internet.

 Agencies active in this field :

Credence Analytics
CRISIL
Lipper
Morning Star.
Value Research