These funds may help you to build equity portfolio; be mindful of market cycles while taking exposures

These funds may help you to build equity portfolio; be mindful of market cycles while taking exposures

By Amar Ranu

Imagine you have a windfall gain of a few crores of rupees either from business or stake sale and you feel that you won’t be lucky next time and hence, you need to invest it judiciously though you are a risk taker. Calling risk taking capabilities and we don’t talk about equity, the marriage won’t be successful. Risk accompanies equity which progresses the path towards handsome returns. So, the question arises – how to build an equity portfolio? Then you meet a distributor who will happen to show you the flavor of season – few investments would be flexi cap funds, multi cap funds, large & mid cap funds, mid cap funds or small cap funds, be it in MF format or PMS/AIF format (least likely that you would be introduced to PMS/AIF if you are getting services from a MF distributor). The basket may end up having few NFOs too including some index funds so as to justify the latter that there should be a portion of low cost investing in the portfolio.

This is a common story amongst investors and so-called self-proclaimed MF distributors/advisors. No one talks about how the equity portfolio they are pitching would look like whether they belong to Quality Compounders or Sector Rotation or Economy Facing or International Funds (be it EM or DM) or Unlisted space. Everyone talks about funds in terms of market cap; e.g. these funds are multi cap or large cap or some other categories. My study says that these 5 buckets are the pillars of an equity portfolio which can be further divided into Core and Tactical.

Quality Compounders – They hold quality, consistently growing and mostly consumer facing stocks which grow at a certain level and are less prone to economic adversity. These would have less beta relative to the market. They would perform in a very narrow market scenario when everything looks doomed. They won’t outperform in an economy driven market or commodity led or broader rally. Very likely that these funds would belong to large caps or multi caps or mid-caps but less likely to small cap categories. These funds tend to be highly valued relative to peers and benchmarks but are less volatile and less beta.

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Sector Rotation Funds – Here the fund manager is the master of foreseeing the upcoming sectors. They change the sectoral allocation depending upon where she/he gauges the upcoming turnaround in sectors. One may not catch it 100% during the start of sector turnaround but even if one enters after 30-50% of the story is played, one can participate in performance significantly. Within sectors too, there is rotation i.e. switching between stocks within the same sector. E.g. participating in large private banks but rotating in between ICICI Bank and Kotak Bank or within autos, whether one is positive on 2W or 4W. In this bucket, the portfolio may not be fully 100% quality compounders but it would be a mix of former and some emerging sectors which were duds in a few quarters//years back. The volatility and beta are mediocre – neither too high now too low.

Cyclical Recovery or Domestic Economy facing Funds – By name, this does not belong to any business cycle funds or some value funds but more of a diversified fund having an economy facing tilt. This helps in capturing the economy when there is a turn around due to improving economic conditions. This happens across sectors like industrial capital goods, industrial goods, Oil & Gas, construction & related items like Building Materials or Cement or in some way, Housing Finance Companies (HFCs) or some NBFCs predominant in Vehicle Financing. These kind of funds help in capturing the overall broader rally in the economy. Generally these schemes have higher volatility and beta.

International Funds – Unlike India domiciled funds, where it is focused towards one geography, International Funds offer exposures across all geographies – be it Developed Markets (DM) like US, Europe, Japan etc or Emerging Markets (EMs) like China, Malaysia, South Africa, Indonesia, Thailand etc. One should be careful and watchful while taking overseas exposures – all countries may not work in one direction. Few countries may work due to their inherent strength like India. At the current juncture, as the Dollar Index is strengthening, Emerging Markets may do well. On the other hand, since most DMs are under inflationary pressure, they may not do well for some time plus they are into sucking surplus liquidity. The recent corrections in both DMs and EMs provide a good entry point to take some pie into the portfolio.

Unlisted Equity – Last few years had been a bandwagon for many new age companies and they created a niche in their space. While investors could participate in a few stories through IPOs, most new age companies / start ups are still in the growth phase or inception phase and they have been growing rapidly. So the question arises how to take exposure into these companies? One can take an entry through growth stage unlisted stocks which are traded OTC; however, one should be mindful of valuations. In recent correction, many unlisted stocks nosedived by 50-60% while the broader market corrected by 10-15% only.

Then one needs to be mindful whether they want to enter into – early or mid or growth stage of their journey. The risk subsides as you go up the ladder; however, the probability of defaults are higher in early stage companies.

What should be the ideal combination?

At portfolio level, 50-60% of the portfolio should be a combination of Quality Compounders and Sector Rotation funds (may prefer one over other depending upon the market scenario), 20-25% should be economy facing as there is change in cycle. Remaining 20-25% could be a mix of unlisted space (Up to 10-15%) and overseas allocation (10-15%). One should be mindful of market cycles while taking exposures into these strategies. It may not be easy to keep a track of all baskets. So, the ideal way is to trust your investment advisors who are well versed with these market cycles and investment products.

(Amar Ranu, Head – Investment Products & Advisory, Anand Rathi Share & Stock Brokers. Views expressed are the author’s own.)