Your Money: Reduce risk in MF portfolio

Don't go overboard on mid-cap funds as volatility is expected in the first half of 2017

Since demonetisation was announced on November 8, the Nifty has fallen 5.95%. The performance of diversified equity funds has been quite divergent. While the fund that declined the least has fallen only 0.82%, the one that has taken the biggest hit is down 11.49%.

With the Indian equity markets expected to remain volatile in the first half of 2017, mutual fund (MF) investors need to tweak their portfolios to deal with this downturn.

The 10 funds that have proved to be most resilient during this downturn have fallen 0.82% to 5% (see table). Funds that follow a value-oriented strategy have weathered the downturn well. "In line with our investment philosophy, we had preferred large-caps and stayed away from expensive segments such as mid- and small-caps purely due to steep valuations.

These were the very pockets which corrected the most during the last two months," says S Naren, executive director and chief investment officer, ICICI Prudential AMC. 

Dividend yield funds, regarded as a subset of value funds, have also fallen less. Funds that took a contrarian call during the year on sectors such as oil and gas and energy have also weathered the downturn well.

These developments underline the need for style diversification. Besides investing in growth-oriented funds, investors also need to have exposure to value-oriented funds, which deal with market volatility better.  

Mid-cap funds, which had rallied between March and October, have fallen more than large-caps (average decline of 8.68% since November 8). "Valuations within the mid- and small-cap segment had gone way above reasonable levels," says Vidya Bala, head of research, Fundsindia.com.

Markets are expected to be volatile in the first half of 2017 due to a variety of reasons: The impact of demonetisation, delay in corporate earnings recovery, rising interest rates in the US (which could lead to more foreign institutional investor or FII outflows), and so on. 

Investors need to pare their exposure to mid-cap funds, which have attracted a considerable portion of retail inflows over the past couple of years. Mid-cap funds tend to be beaten down more than large-caps in falling markets.

"Investors over-exposed to mid-cap funds should move a part of their funds to large-cap and multi-cap funds, which contain volatility better," says Bala. She warns that mid-cap funds may correct further, going by the overvaluation in this space.

Limit your allocation to mid-cap funds to 20-30% of your equity portfolio. Avoid small-cap and micro-cap funds and stick to mid-cap funds that invest in larger mid-cap stocks, where the level of liquidity is better. Stick to systematic investment plans and avoid lump-sum investments in the mid-cap space. Naren suggests retail investors can opt for dynamic asset allocation funds if they wish to make lump-sum investments.  The market correction has also brought to the fore the importance of international diversification. PPFAS Long-Term Value Fund, which has a 28.57% exposure to overseas stocks, has weathered the downturn well. 

MF

"Different markets perform well at different points of time. By combining exposure to domestic and international funds, Indian investors can diversify their equity portfolios better and reduce volatility," says Rajeev Thakkar, chief investment officer and director, PPFAS Mutual Fund. He suggests investors should take the help of a financial advisor to arrive at their ideal asset allocation and stick to it under all circumstances.