41-Year-Old with a Diversified Portfolio: Seeking Advice on Fund Optimization

Ans: You have a good selection of mutual funds in your portfolio, Sir. Your current portfolio includes funds from different styles, such as flexicap and hybrid funds. This provides a decent mix of growth, value, and diversified investment strategies. However, there are a few aspects you should consider to improve the overall alignment with your long-term goals.

Let’s go through your current funds and evaluate their strengths and areas where changes might be beneficial.

Flexicap Funds in Your Portfolio
You have multiple flexicap funds in your portfolio:

Parag Parikh Flexicap
HDFC Flexicap
Canara Robeco Flexicap
Franklin India Flexicap
Flexicap funds are versatile as they invest across large, mid, and small-cap companies. This gives you flexibility to capture opportunities across the market, making them an attractive choice. However, having too many flexicap funds can lead to overlap, meaning you might be investing in the same stocks repeatedly, reducing overall diversification.

Points to Consider:
Portfolio Overlap: Since all these flexicap funds invest across market caps, there’s a risk of them holding many common stocks. This dilutes the benefits of diversification.
Fund Styles: Each fund house follows a different style—some focus more on large caps while others tilt towards mid or small caps. But, having too many funds in the same category could lead to inefficiency.
SBI Long Term Equity Fund (ELSS)
This fund falls under the Equity Linked Savings Scheme (ELSS) category, which offers tax benefits. It's a solid choice if you're looking to save tax under Section 80C, but keep in mind that ELSS funds have a three-year lock-in period.

Points to Consider:
Lock-in Period: Your SBI Long Term Equity Fund comes with a lock-in of three years, but that can be a good thing as it forces you to stay invested.
Growth Focus: The primary focus of this fund is growth, with a tendency to invest in companies with higher growth potential.
ICICI Prudential Equity & Debt Fund
The hybrid nature of this fund provides a balanced approach by investing in both equities and debt instruments. This fund is less volatile than pure equity funds and offers a cushion during market downturns. It also provides you with some stability, which is essential as you grow closer to retirement.

Points to Consider:
Balanced Approach: This hybrid fund adds stability to your portfolio with its debt exposure, which is crucial, especially in volatile markets.
LTCG Taxation: Be mindful that when you sell this fund, the taxation will follow the LTCG rules for debt funds, which is different from pure equity mutual funds.
Assessing the Mix of Investment Styles
Now, let's analyse the mix of investment styles in your portfolio—growth, value, and momentum. Here's how your current funds line up:

Growth: Parag Parikh Flexicap and Franklin India Flexicap have a strong growth focus. Growth funds invest in companies expected to grow at an above-average rate compared to other companies. This brings higher returns but can be riskier.

Value: HDFC Flexicap and Canara Robeco Flexicap have a more balanced approach with some value-oriented strategies. Value funds focus on undervalued stocks, aiming to capitalise when the market recognises their true potential. This approach is less volatile.

Momentum: Currently, your portfolio lacks a specific momentum-oriented fund. Momentum funds focus on stocks that have performed well recently and are likely to continue doing so in the short term.

Points to Consider:
Balanced Style: You already have a good mix of growth and value funds. Adding a momentum fund could diversify your investment styles further, making your portfolio more dynamic.

Avoid Overlap: While flexicap funds are flexible, too many similar funds could lead to over-diversification. This may reduce your portfolio’s efficiency in terms of returns.

The Importance of Adding a Value Fund
If you want to enhance your portfolio’s exposure to different styles, you could consider adding a fund focused entirely on value investing. Value funds are often overlooked, but they play an essential role during market corrections or periods of economic downturn. They seek to invest in companies that are undervalued, offering long-term potential once the market realises their true worth.

Points to Consider:
Balancing Risk: Value funds are less volatile and provide stability during downturns. They can serve as a cushion for your portfolio, balancing out the riskier growth-oriented investments.

Long-Term Growth: A value fund’s slow but steady performance can help you achieve stable growth in your portfolio over the years.

Diversification of Market Capitalisation
You currently have exposure to large, mid, and small-cap companies through your flexicap funds. However, it might be helpful to examine how much of your portfolio is concentrated in large-cap stocks versus mid and small caps. Large caps provide stability, while mid and small caps offer higher growth potential but with increased risk.

Points to Consider:
Large Cap Stability: Ensure that a reasonable portion of your portfolio is in large-cap stocks. This will provide your portfolio with stability and reduce overall risk.

Mid and Small Cap Growth: Mid and small caps offer higher growth but can be volatile. Make sure you’re comfortable with the risk that comes with these investments.

Disadvantages of Index Funds in Your Portfolio
You’ve wisely avoided index funds, which tend to underperform compared to actively managed funds, especially in the Indian market. Index funds simply track the market, offering no opportunity for active stock selection. In contrast, actively managed funds allow fund managers to pick stocks that have the potential to outperform, especially in volatile markets.

Points to Consider:
No Active Management: Index funds offer no opportunity for active management, which can limit your returns in the long run.

Outperformance Potential: Actively managed funds have the potential to outperform the market, especially during downturns. The fund manager’s expertise becomes a crucial advantage.

Disadvantages of Direct Funds
Direct mutual funds may seem appealing due to their lower expense ratios, but investing through a regular plan with a Certified Financial Planner (CFP) has significant benefits.

A CFP will help you manage your portfolio more effectively by offering timely advice, rebalancing your investments, and ensuring you’re aligned with your goals. Direct funds lack this guidance, leaving you on your own to make important financial decisions.

Points to Consider:
No Professional Guidance: Direct funds offer no advisory support. You may miss out on crucial market insights that a CFP can provide.

Portfolio Mismanagement: Without professional advice, you could overexpose yourself to risk or miss opportunities to rebalance your portfolio.

Taxation Aspects of Your Portfolio
The new mutual fund taxation rules can impact your returns:

LTCG on Equity Funds: Long-term capital gains above Rs 1.25 lakh are taxed at 12.5%.

STCG on Equity Funds: Short-term capital gains are taxed at 20%.

Debt Funds: Both long-term and short-term capital gains are taxed as per your income tax slab. This is important to keep in mind when selling any debt portion of your hybrid fund.

Points to Consider:
Tax Efficiency: Hybrid and debt funds can impact your tax liability, so plan accordingly when making withdrawals.

Equity Taxation: Your equity mutual funds will give you tax-free gains up to Rs 1.25 lakh, making them more tax-efficient in the long run.

Finally
Your portfolio has a strong foundation, but it could benefit from further optimisation. By reducing overlap in flexicap funds and adding a value-focused fund, you can diversify your investment styles more effectively. Consider adding a momentum fund to enhance your portfolio’s dynamism.

It’s also wise to keep an eye on the allocation between large, mid, and small caps. While your hybrid fund provides stability, ensure that your overall exposure to equities aligns with your risk appetite as you approach retirement.

Lastly, avoid the temptation of index and direct funds. They may seem cost-efficient, but they lack the advantages of active management and professional guidance, which can make a big difference in long-term wealth creation.

Best Regards,

K. Ramalingam, MBA, CFP,

Chief Financial Planner,

www.holisticinvestment.in

https://www.youtube.com/@HolisticInvestment