Portfolio Construct

How Many Mutual Funds Should You Have in Your Investment Portfolio?


This is a trick-question as how many and which type depends upon a host of factors such as my risk appetite, financial goals etc.

Time to take an inventory of your mutual funds. How many are there? What are their investment styles? Is your portfolio of mutual funds cluttered just like your closet? Have you owned some mutual funds so long that you have forgotten why you bought them? Are there some mutual funds on the top shelf, way in the back of your financial closet you haven't even looked at in a while?

Adding new mutual funds to your portfolio is far easier than reorganizing your fund portfolio and discarding inappropriate, redundant, or simply poor-performing mutual funds. The answer to the question of how many mutual funds you should have in your portfolio is not just a number. But if you have many more than eight mutual funds in your closet, chances are you need to do some serious portfolio cleaning; and here's why.

First, in order to be well-diversified, your mutual fund portfolio should be invested in stock mutual funds and in fixed-income mutual funds or income fund equivalents. Within the stock mutual funds, your mutual funds should cover large-cap stocks, small-cap stocks, and mid-cap stocks.

In case you are making investments across the shores, one should cover established firms in industrialized countries and stocks of countries that would be considered emerging markets. While geographic diversification domestically is relatively unimportant, diversification by region for foreign investments is. Representation in Europe for large stock international mutual funds is important, and investments in Latin America and the Pacific Rim are crucial when considering emerging stock mutual funds. Global mutual funds that invest domestically and abroad sound like a one-fund answer, but it is too much geography for one portfolio manager to cover and global funds tend to change domestic/foreign portfolio weights as world conditions change, neutralizing some diversification benefits.


Counting the Mutual Funds
Let's stop and take a count: one large-cap fund, one small-cap fund, one emerging sector fund—so far, three mutual funds. Have we missed the mid-cap stocks? Well, check your large-cap fund and your small-cap fund to see what they include. Usually, large-cap funds leak down into the mid-cap range and small-cap funds push up into the mid-cap range. If not, add a mid-cap mutual fund to avoid any portfolio gaps. Now we may be up to four, all of which are stock mutual funds at this point.

If you want income and the diversification benefit of a fixed-income fund, then a simple choice would be to consider Debt mutual funds with a decent focus towards Government Bonds. These funds on a 3 to 10 year weighted average maturity deliver stability in the portfolio and captures most of the yield of longer-term mutual funds when interest rates change. If you are in a high tax bracket, a stable tax-saving fund might be a better choice. Aggressive investors can reach to high-yield corporate bond funds and while these funds invest in lower-quality corporate debt that pays high income, the individual default risk of the bonds in the portfolio is softened through diversification and the high income dampens portfolio volatility. Furthermore, high-yield bonds tend to be sensitive to the economic cycle, acting more like stocks than government bonds.

So, if we add one to our fund count for a fixed-income fund we have a total of five mutual funds; and another in GILT securities fund would push the kitty to six.


Other Categories of Mutual Funds
What about all those other categories of mutual funds? Do you need a gold fund, sector fund, index fund?

Let's take them one at a time...

Gold mutual funds are concentrated sector funds holding gold mining stocks primarily in North America, South Africa, and Australia. They are extremely volatile, as gold price changes are magnified by the operating cost break-even points of gold mining firms. Do you need a gold fund in your portfolio? No. Most investors use gold funds as a store of value, a hedge against inflation. Over the last decade, however, they have been neither. When stocks are roaring up, you would like your gold fund to behave like a stock, but it tends to act like gold bullion. When the stock market collapses, you hope your gold fund behaves like gold bullion, but unfortunately, it tends to act more like a stock. Hence, I would then rather take a Gold Exchange Traded Fund which is Gold Bullion in that case and would actually provide the hedge the portfolio needs especially given the volatile times we are in.

Sector mutual funds concentrate on one industry or a few closely related industries. Because they are concentrated in an industry, they are not well diversified. Beyond the additional risk, the trick to master is just which sector funds to invest in. At the top of most "best-performing mutual funds" lists will be some sector funds, but they'll also appear on the "worst-performing mutual funds" lists—it's just a question of when. Most aggressively managed stock mutual funds concentrate in some industries and might be viewed as a combination of sector funds. Few investors are willing and able to place sector bets unless they have particular experience in a sector through their education, work experience or vocation, and if they do have expertise, selecting individual stocks may be more rewarding. So, unless there are strong convictions on a sector and one doesn't really have the time to pick up stocks

Do index mutual funds have a place in your portfolio? Yes, but they don't add to the number of funds. They simply are another way of managing your assets in one of the fund categories necessary for a rational, well-diversified, non-redundant mutual fund portfolio. Index mutual funds should be employed in a situation where even the brightest and best of portfolio managers using superior timing and stock selection decisions would have difficulty overcoming the cost advantage of an index fund. Areas of the markets that are efficient, have readily available information, are well-researched and followed closely by the investment community, or are simply not susceptible to very profitable analysis are candidates for indexing. These markets have attributes that make intelligent, thorough analysis more likely to contribute returns that can overcome the cost of active fund management.


Style Diversification in a Portfolio of Mutual Funds
An added classification for domestic funds is investment style—mutual funds can be categorized as growth or value, or both. Growth mutual funds would typically invest in stocks with high earnings growth expectations; value mutual funds would invest in stocks with low prices relative to earnings and net asset values. The style label should be based not on what the fund says it is or what it says it will do, but on what it does. Investment style classification should serve to help investors avoid redundancies and coverage gaps. But they also beg the question, "Should a portfolio of stock mutual funds be diversified by style as well as size of stocks?" Size, yes. Style, perhaps.

Many mutual funds operate in more than one stock size range and many use approaches that are classified as both growth and value. Do you need a value and growth fund in each stock size category? No. One value fund, and it might be the large-cap fund, and one growth fund covering the mid-sized and small stock area provide coverage of size and style. An index fund can be both growth and value, and more extensive indexes will cover value and growth for more stocks and stock size ranges.


Eight Is Enough…
Understanding the style and stock size characteristics of mutual funds will help prevent duplication and unnecessary run-up in the number of mutual funds in your portfolio. Now, back to our count of mutual funds: We left off at six with one fixed-income fund, or seven funds with a fixed-income fund and GILT fund. Add a money market fund and the counter clicks to eight. Be sure you can justify adding mutual funds to your portfolio beyond eight. Make certain you need them, that they truly cover new ground in asset type, geography, or investment style, and that the addition is meaningful.

Taking the time to create an organized, understandable, appropriate and efficient portfolio of mutual funds may be your most important investment.


But, What if one doesn't have time...
Off late, funds with hybrid asset allocation have become popular. These funds invest in different assets (debt & equity) on the basis of predefined asset allocation (moderate / low / aggressive). Also, there are funds with dynamic asset allocation on the basis of statistical models (quant models). Investing in these funds would enable you to have the same exposure to asset classes and reduce the number of overall investments. This is best suited for a person who doesn't take active calls between equity & debt.



The response is inspired by John Markese's response to a similar question put up to him in the AAII Journal, and adapted to the Indian context. John is the President of AAII, the American Association for Individual Investors. I also thank Rajnish Girdhar, Anamika Mattey and Manish Rangwani for their inputs.

EDGEXTREME: An Urban-Outbound program sensitizing learners on what it takes to be a CEO

Preface

Early last year, I launched EDGEXTREME, a one-day urban outbound program that focuses on sensitizing learners to what it takes to be a CEO. EDGEXTREME was built from scratch (even scratch was an understatement)... so, no IP issues.

We have run 10-odd sessions across the country, and have recieved wonderful responses. More importantly, those who have attended remember the exercises, and many a times have met me and shared the application of its learning in their workplace.

The training program is labour-intensive (requires 12 people apart from the core facilitator), takes one day to map the geography plus another day to do the on-ground planning a day prior to the program, and is not exactly inexpensive.

Apart from the resources that are required, the most critical and difficult resource to source is a detailed map of the locale. We source these maps from Reliance GIS.

The following write-up is given to the nominees to arouse their interest. To conduct this program, one requires teams (min.-5; max.-10) constituting of participants (min.-4; max.-5) who are mature, have led large teams, and typically have been identified as 'high potentials'. Inexperienced and immature learners tend to remain stuck on their immediate wins & loses, and miss the larger picture. After the debrief, the participants are given a handbook which has some tools and also a Harvard-appraised Case Study, The Team That Wasn't.

Overall, an interesting experience for both the participants and the crew & facilitator(s) as well. Tiring, but enjoyable!!!



Background

When tackling a major initiative like an acquisition or an overhaul of IT systems or introducing a new product line, companies rely on large, diverse teams of highly educated specialists to get the job done. Teams often are convened quickly to meet an urgent need and work together virtually, collaborating online and sometimes over large distances.

Appointing such a team is frequently the only way to assemble the knowledge and breadth required to pull off many complex tasks businesses face today. When the BBC covers the World Cup or the Olympics, for instance, it gathers a large team of researchers, writers, producers, cameramen, and technicians, many of whom have not met before the project. These specialists work together under the high pressure of a 'no retake' environment, with just one chance to record the action.

A leading sales organisation's newly appointed CSO was interviewed before the launch of a 'focused' sales drive. He was asked which was to be done first; a clearly defined approach toward achieving the goal, or clearly defined roles of individual crack-team members. He chose the former. The common assumption is that carefully spelling out the approach is essential, and leaving the roles of individuals within the team vague will encourage people to share ideas and contribute in multiple dimensions. Research shows and so did he realise shortly, the latter needs to be defined first; Collaboration improves when the roles of individual team members are clearly defined and well-understood – when individuals feels that they can do significant portion of their work independently.

Recent researches into team behaviour reveal an interesting paradox: Although teams are large, virtual, diverse, and composed of highly educated specialists are increasingly crucial with challenging projects, those same four characteristics make it hard for teams to get anything done. To put it another way, the qualities required for success are the same qualities that undermine success. Members of complex teams are less likely – absent other influences – to share knowledge freely, to learn from one another, to shift workloads flexibly to break up unexpected bottlenecks, to help one another complete jobs and meet deadlines, and to share resources – in other words, to collaborate. They are less likely to say that they "sink or swim" together, want one another to success, or view their goals as compatible.

We would examine these aspects of High Performing Teams and some more in a simulated context; followed by a structured debrief to highlight the competing-teams' performance which in turn would help the team members to sensitize themselves to various aspects of a team's effectiveness.



The Structure

        Briefing >> Exercise >> DeBriefing




The Field Exercise

EDGEXTREME is a 1-day outbound navigation based field exercise. It would take you on an adventure trip, around the city & the suburbs, and compel you to think differently, pushing you to the limit where innovation & collaboration would be the only means to move forward. It is a physically as well as mentally strenuous exercise. You would be competing with teams from other organisations.

EDGEXTREME will not only challenge you to achieve the impossible but also surprise you with your own achievements. The exercise is designed to be an experiential exercise which takes participants through a journey of avenues to explore themselves and get sensitized to tenets of Co-Competing.


Dress Code
Casual comfortable clothing and sport shoes.


Limitations
The limitations are just in our mind; and although the intervention would require you to be outside 'in-the-heat', and it may be physically tiring for you, but the learning & its application will be profound. Having said that, as the intervention may be physically exhausting, if you suffer from any prohibitive ailment or your doctor has advised you not to exert, you are advised to refrain from participating in the program.



The Debrief

EDGEXTREME examines the structure of teams in the workplace, a heuristic model of the various elements that impact a team's effectiveness, and finally the factors that lead to a team's success which you can implement to take yourselves and your working teams to a different orbit.



Acknowledgements


A lot of people have been involved, and at various stages, right from inception to its shape-n-form today...

1.        Inception - Gopal Khaitan, Premal Pipalia, Vikram Masand
2.        BrainPicking - Anand Dewan
3.        Development - Vikram Masand
4.        Logistics - Mihir Shah
5.        Maps - Jagadeesh KM, Kenneth Crasto
6.        Devil's Advocate - Premal Pipalia, Vikram Masand, Ankush Roy, Mihir Shah, Shyamac Jal

Is my employment a 'job' or a 'venture'?

My work is a job!

A colleague in the L&D fraternity recently told me that she wasn't happy with the way in which she was treated during the annual appraisal process; I mean her expectations in terms of a raise weren't met, although the raise she got was in line with what the top quartile got. Having said that she has been unhappy, and told me that if I were her supervisor, she would tell me that the 'experience has led me to look at my work as a job rather than a venture'.



...and if I were her supervisor, I would have told her that it would be an interesting experiment!

An interesting experiment because, I believe that the 'orientation' can't change overnight... i.e., whether to take one's work as a 'job' or as a 'venture'. I tried it, but somehow came back to the 'venture' orientation, and I know people whom I could never get to move from the 'job' orientation; that is when I realised that these are not mere orientations, but a 'way of life'.

She has a 'venture' orientation which is her base attitude, if she can change that, she would have proven me wrong... and I really don't mind being proven wrong. At least I, as her supervisor, would know that I have one less name to count on.

Behaviours are a manifestation of the 'attitude' in differing environments. Environments are temporary, and hence behaviours are! Behaviours create perceptions; they are temporary as well. Our effort, as evolved individuals, should be to not let these perceptions stay long and affect us and others around us, as they then start metamorphosing into biases; and biases are difficult to break, and in some cases run across generations as well. The environment today may not be conducive, but that doesn't stop one from being selfish, and continue to hone our 'venture' skills!

Its just a thought...



My failing memory...

She ended the conversation by saying that 'the one who wears the shoe knows where it pinches'. I kept quiet & smiled, for she was hurt and refused to look around at others. Have I had this kind of feeling earlier; well, I guess we all have had, but the question is 'how have we handled them, and have we come out stronger'.

Today, I know I am stronger, but, ironical as it may sound, I don't even remember the details of the 'hurt'.

Is my memory failing me, or was the 'event' insignificant?