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Portfolio Managemt Strategies | Types | And A Comparision

Whether it is a mutual fund or personal investment.  At last portfolio is a portfolio. No difference. Without strategic portfolio management, it’s very difficult to achieve the target. Investment into different asset classes like equity, debt, gold and cash will give the returns of different percentages and at different time periods. So, there is a need to manage, the balance between different asset classes. That’ where a strategic portfolio management plays a vital role.


STRATEGIES

Active Strategy

An active portfolio management strategy focuses on outperforming the related specific benchmark index that comprises of the assets in the portfolio. Either an individual investor /a broker /a mutual fund, the strategy remains same. Just outperforming the specific related Benchmark Index.

Suppose you might have come across the news that, BSE Midcap Index has fallen by 12% since the beginning of 2018. And’ all the Midcap Mutual Fund Schemes have fell lower than their respective benchmarks. But, Axis Midcap Scheme shown positive return of 0.74% from Jan’18 to June’18.

How it Works

Let’s better to explain with an example.

An investor  Mr. Gentleman aged 40 years has invested his savings of Rs. 10,00,000 in different asset classes as follows.

 

Initial

Asset Allocation

Amount Active

Asset Allocation

Amount
Equity

Debt

Gold

Cash

4,00,000

2,00,000

3,00,000

1,00,000

Equity

Debt

Gold

Cash

2,50,000

3,50,000

3,50,000

50,000

After allocating the total amount to gain under different classes, there was a signal of equity market down-trend. Then, to save his corpus, he planned to reduce the amount of equity exposure. So, he reduced the equity amount from 4  lakh rupees (40%) to 2.5 lakhs (25%). And, to safeguard his return, he transferred that amount to debt and Gold.

Here, the investor /portfolio manager has applied the active portfolio management strategy by timing the markets. And, trnsformed the existing portfolio to the new strategic portfolio comprised of same asset classes but with different asset allocation percentages. Sometimes, the strtegic portfolio management brings in new asset classes by the investors /portfolio managers, which they expected to be the best future performers.

After a year, his expectation got true and market had underperformed by 40%. That has similar effect on his equity investment. So he lost  Rs. Rs. 1,00,000 in equity and  instead of Rs. 1,60,000 if he might have invested Rs. 4,00,000. So, more exposer to the debt and gold has earned him more money in the form of interest and gold price appreciation. That’s how the strategic portfolio has saved him from big equity loss and earned extra money.

For each strategy there is always a second side of possibility. Let’s consider the scenario that markets moved forward and up by

 

Hedging With Derivatives | An Advanced Stock Investment Strategy

This article is of little use to those investors who are expert derivative traders and know, how to use hedging for their portfolio against market risk. But, of utmost know to factor to the investors, who are away from the derivative segment and are likely to know about. Let’s read.


What is Hedging and Who is a Hedger

A strategic trading strategy in the derivative market, to protect the value of equity portfolio against price fluctuations is called hedging. When there is an uncertainty in the price movement of any stock, stock investors can hedge the price of a stock from a fall, by participating in the derivatives market. And, such investor is then called to be a Hedger.

Hedging is nothing, but securing the price of a stock by speculating market movement. In other words, it’s an advanced equity investment strategy, where the equity investments are protected in the market fall /fall in the price of a stock scenario. Hedging gives a sort of ‘peace of mind’ to the equity investors, by ensuring a more predictable outcome.

Hedging of a Stock doesn’t give more outcome, but it definitely gives a more predictable outcome.

What Are The Types Of The Risks Associated With Any Stock

While buying a stock every investor thinks and hopes that, it will move forward and there will be a hike in the stock price. But, nobody can make sure that the price hike is definite. There are certain risk factors, that may restrict the stock price, and push it down.

The stock price is always a function of many risk factors, which will decide its future. Some are specific to the particular stock and sector. And some are global. Market risk is considered as an external risk factor that will equally affect the entire industry. For example, currently the Diamond Industry, is facing such a type of Market Risk. Which is unavoidable by all the stocks of various companies that belong to this industry.

How To Hedge A Stock

Hedging is an art of ensuring the return of an equity investment apart from market risk. This is done by participating in the derivatives market, and execute exactly the opposite trade. That means, the trade which  opposite to the trade in equity segment. By doing so, one can ensure the return from either the equity /derivative market, as the two segments move in opposite directions. In this form, one can bypass the risk to those who are willing to bear it.

There are two types of derivative contracts, that help the investors to hedge their investments in the cash segment, that is equity. They are Futures and Options.

For example Mr. A holds 100 shares of a company XYZ. If the buy price is Rs. 10 per share, and the stock price is hovering around Rs 10 and Rs.12, for a month. Then Mr. A speculated the price movement towards negative direction. And, he decided to liquidate his holding predicting its future fall. But, his advisor and friend, Mr. B suggested him to hedge his holding  to ensure his future earnings at the cost of the premium to be paid to buy a contract in the derivatives segment. So, Mr. A postponed the idea of selling the shares at the current market price. And, decided to sell the stock at the expected Rs. 15 after 3 months.

Even though there are many contracts to hedge the stock value in derivative segment, the best one is the PUT Option, which he can utilize to sell his stock after 3 months and at the strike price.

Put Option gives the buyer to sell the stock  during a predetermined period and at the predetermined strike price, which is usually above the market price.

The cost of buying a Put Option increases with strike price. That means, higher the strike price, the higher the cost. So, it is always advisable to choose the strike price moderately to hedge the stock.  So, Mr. A chose to buy the 1 ATM Put of 100 shares with the 3 month expiration period.  He paid Rs. 100 towards premium and his strike price was Rs.11

As per his expectation the price of his stock fell to Rs.10. And, Mr.A exercised his option to Put his quantity of 100 shares at Rs. 11 each. The amount he received was Rs. 1100. So, the loss is only the amount that was paid towards commission while buying the stock. In India the Futures and Options, of all the listed stocks expire on the last Thursday of the contract month. If that Thursday is declared to be the holiday, the expiry day will be the preceding Wednesday.

If you like my article, leave your comment. I value your comments, and try to rectify my defaults.

Happy Investing!

 

The Best Mutual Funds | How To Select

Plenty of Mutual Fund offers. Plethora of information. But, of no use. When it’s time to invest, it’s a common man’s common problem to choose the right one. Try to investigate. Most of the people are stuck in Funds, that were performed well in the past. But currently, not even meeting the benchmark index. All this happens, only when the investor lacks proper knowledge about guidelines, that need to be followed, while investigating into the Mutual Funds.


It’s simple, to pick a well suited Mutual Fund, that matches our requirements. Fund houses are ready with variety of Mutual Funds, that are well tailored to match the financial requirements of people from all walks of life. They are well planned and designed, keeping in mind the financial obligations of different streams of investors. So, it’s our choice to pick the right one to meet our financial goals.

Here are certain guidelines to come up that winner to suit to your financial goals. Let’s Beat the Benchmark Index like a Pro.

Know Your Goals, Risk Profile And Investment Horizons Before Choosing A Mutual Fund

The goal or the investment objective should be the first criteria while choosing the mutual fund for your investment. Goals can be classified as high, medium and low in terms of capital gains. Risk and return go hand in hand. High goal seekers with aggressive return expectations are compulsory to invest in equity oriented mutual fund schemes. These are comparatively riskier than other types of funds, with huge return opportunities. Debt funds are always there for risk averse medium and low goal investors.

A picture of a man's hands , calculating mutual fund returns and writing on a sheet.

An investor with long-term investment period is best to choose a long-term capital growth equity or balanced fund. A young investor with long-term goals, which would probably be high falls in this category. But, an investor with near and medium-term targets are better to engage with short-term debt oriented mutual fund schemes.

What is the category to select?

Debt? Equity? Or Hybrid? Your age, risk taking capacity, investment horizon and future targets are the factors that decide upon the category.

Check Back The Fund Managers Past Performance

Few funds are managed by an expert team. And, few are by a single star fund manager. In the first case, where there is an expert team to manage  the fund the performance would be very clear and peaceful.

Whereas, the fund managed by a single expert manager, we need to look his / her past performance track record. This facilitate us to guess his /her future performance.

Consistency Is The Main Criteria

Duly have a check on the fund performance during those market fall periods. If the fund had done well even in the bear phase, we can say that it has beaten the index.  Otherwise, if had done well in the bull market, and became dull during the fall, it’s a type of fair weather friend. Keep it away.

Consistency in performance is the symbol of its stamina to win. One can be sure to assume that it will beat the Index in the future too. Good to look for the consistency in performance, over longer periods like 3, 5 and 10 years. Have a look at NAV’s of past years. Look for its growth percentage.

Know About The Fund House’s Pedigree

The track record of a fund house is as important as any other factors that help us in selecting a good mutual fund. Try to identify, fund houses with a strong presence and excellent track record in the financial world. Such fund houses have their own investment experiences as well as efficient processes. Consistency in returns is the main feature of these schemes. Sustained performance over a long period of time results in consistent returns.

Make Use Of Statiscal Measuring Tools /Metrics

There are certain risk measuring statistical tools, that may otherwise indicate the investment risks associated with their returns. These indicators make use of historical data for the analysis of not only mutual funds, but also the stocks and bonds.

These ratios simply compare the mutual fund return with the market benchmarks.

Alpha (α)

The simplest definition of an alpha would be the excess return of a fund compared to its benchmark index. If a fund has an alpha of 10%, it means it has outperformed its benchmark by 10% during a specified period.

Beta (β)

Beta measures the mutual fund’s performance-swing /volatility, compared to a benchmark.

For example, a fund with a Beta of 1 means it’s NAV will move 10% upside↑ /downside ↓ in respect of the benchmark index.

High Beta – For aggressive goal seekers with risk taking capacity for the possible high returns

&

Low Beta – For less aggressive, risk averse investors, who are seeking for stable returns.

Standard Deviation (σ) (SD)

It’s the statistical return measuring method. It actually measures the deviation of returns from their mean value. In Mutual Funds, Standard Deviation  is used to measure the possible deviation in returns from its historical mean value.

Assume that a Mutual Fund with an Average Rate of Return of 12%. And a Standard Deviation of 3%. Then,  this Mutual Fund has the possibility of giving returns which will vary from 9% – 15%.

So, it is most obvious that, risk taking investors will prefer to choose funds with high Standard Deviation (SD). And risk averse, the funds with low SD.

Sharpe Ratio

One of the most popularly considered and used indicators to measure, Risk Vs Return is Sharpe Ratio. It was developed by Nobel Laureate William F.Sharpe. Hence is known as Sharpe Ratio.

Each investment in the Mutual Fund Portfolio comes with its own degree of risk. Returns should always be in proportion to the amount of risk taken by any investment. Only such investments are worth buying.

Sahrpe Ratio measures the excess return per unit of risk taken over the risk-free return. Here, risk-free return is the return given by risk-free instruments like Treasury Bills and Government Bonds

Sharp Ratio (S) = (Mean Portfolio Return-Risk Free Rate) /Standard Deviation of the Portfolio Return

Symbolically,

(S) = rp – rf /σp

The Sharpe Ratio tells, how well the Mutual Fund has performed in proportion to the risk taken by it.

The higher the Sharpe Ratio, the better would be the ‘risk-adjusted- return’ of the Mutual Fund Portfolio

A good mutual fund is one which gives better returns than its peers for the same kind and amount of risk taken.

Loads and Charges

As said by the American Science Fiction Writer and Novelist, “Nothing of Value Free…..”, applies to Mutual Funds also. As an investor, it is very important to know the charges levied by the Mutual Funds. Less or more, directly or indirectly all those Fund Managing and Distributing expenses are collected from the investors anyhow. But, where the care should be taken is to select the Mutual Fund that charges less.

There are two types of fee that an investor need to pay as one time payment. They are broadly,

Loads

Entry Load

This load is levied at the time of buying the Mutual Fund Units. Actually, this entry load is collected by selling the units at a higher price than the existed unit price. So, the purchasing price hikes. But, this load has been abolished by SEBI in August 2009. So, no need of worrying about it.

Exit Load

This load is a factor of the holding period. If an investor stays invested till the end of the holding period, as mentioned in scheme related documents, it is exempted. No exit load is charged.

Before the holding period, it will be charged at the rate as mentioned in the scheme related documents. Usually, the percentage of charging varies from 0.5% – 3%. And, this charge is collected by the fund, by buying back the units at the lower than the current NAV.

Hence, if the investor is not sure about the holding period, better to choose a scheme with lower exit load.

Charges

Transaction Charges

These are also one time charges, to be paid by the investor at the time of purchasing the scheme. These are collected by the fund to pay to the intermediary /distributor. Hence, is also known as a Sales Load.

This fee is applicable for the investment amount of over Rs.10,000/-.

Rs.100/- for the SIP commitment of Rs. 10,000/- or above. These charges are deducted over 4 installments starting from the 2nd installment to 5th installment.

Recurring Charges

These expenses are charged on a daily basis and is deducted from the net asset value. The daily NAV is declared after deducting /adjusting these expenses. There are certain guidelines and mutual funds can’t charge more than the stipulated fee structure.

Even though, the fee structure is regulated, it varies based on the Net Assets of the Mutual Fund. More the net assets held by the fund, less are the recurring expenses and vice versa.

Expense Ratio

When you come up with Mutual Funds of similar nature, the next step is to consider their expense ratios. It’s better to choose the fund with low expense ratio. This will benefit you in the long run.

The whole fixed expenses of the Mutual Fund are spread out equally over the investors. In the case of funds with higher asset base, these expenses are spread over the large number of investors. Hence, the higher is the Assets Under Management, the lower is the ‘Expense Ratio’ or ‘Expense to Assets Under management Ratio’.

So, it is advisable to choose funds with high ‘Assets Under Management (AUM)’, and avoid the funds with less Asset Base /Assets Under Management.

Portfolio Turnover Ratio

The total cost incurred by the scheme is a function of the turnover ratio. The greater the ratio, the more is the cost charged by the fund. So, a fund with the lower turnover ratio is preferable over the fund with a higher turnover ratio.

FMP’s | Are Not Guaranteed Return Schemes?

Fixed Maturity Plans /FMPS are also known as ‘Fixed Term Plans‘. These are ‘Close Ended Schemes’ floated by various Mutual Funds. The maturity period ranges from 1 month to three/five years. The tenure is fixed. Even though, almost all the FMPs are predominantly debt oriented, some of them may have small equity component. The objective behind this is to protect the investor’s investments from market fluctuations and to ensure the guaranteed returns over a predetermined fixed tenure /maturity period.


How Do Fund Managers Manage The FMPs

Fixed Maturity Plans are passively managed by the Fund Managers in the favor of investors to generate a fixed income over the fixed investment tenure. Fund Managers lock the investments in the debt securities, whose maturity period coincides with the maturity period of the plan.

As said before, FMPS are the closed ended debt mutual fund schemes with fixed tenure. So, these closed end schemes typically invest the major portion of about 80% in risk free debt instruments like AAA rated bonds, and the remaining 20% is routed towards the riskier avenues like equity.

It is the very structure of FMPs, that ensures the protection of capital as well as the expected return. By the end the stipulated period, the debt portion of the total investment grows to give back the principal along with its interest return. The return on the equity portion is related to the existed market situation. And the return fluctuates as per the fluctuations in the market. In the up market condition the return is good and the equity portion brings the potential upside. Similarly unfortunate market crashes may bring back the minimum, but the corresponding unfortunate loss.

Where Do The FMPs Make Their Investments

The debt portion of FMPs usually invests in commercial papers (CPs), money market instruments, certificate of deposits (CDs), corporate bonds and sometimes even in bank fixed deposits. Depending on the tenure of the FMP, the fund manager invests in a combination of the above mentioned instruments of similar maturity. Say, if the tenure of the FMP is about a year, then the fund manager invests in paper maturing in one year. The expense ratio, usually varies from 0.25 to 1 per cent.

Why FMPs Are Not ‘Guaranteed Return Schemes’

It’s true that FMPs offer many advantages over other fixed income products. But, at the same time, there are several risk factors that need to be concerned. These risk factors, sometimes may adversely affect the returns. That’s why FMPs are ‘Not Guaranteed Return Schemes’. In other words, the returns that the plan promises at the time of investment is only indicative.

To get back the indicative returns, we need to avoid those risk factors anyhow. Few risk factors that we need to be concerned are mentioned below.

Default Risk

Bank Certificates Of Deposits are the safest debt instruments with zero default risk. Whereas Commercial Papers offer higher interest rates with more risk. So, indicative portfolios with the major portion 0f corpus in less /zero risk instruments like Bank CDs is best to choose to avoid the default risk. If, one has the capacity to bear the default risk, then indicative portfolios with predominantly invested in Commercial Papers are best to invest. One can expect more returns.

Credit Risk

You should also check the scheme’s offer document for the minimum credit rating of the securities the fund intends to invest into. The investors should also note that the higher the credit ratings of their securities, the lower the returns would be for the FMPs and vise versa. However lower credit rating securities have higher credit risks; hence investor should keep in mind the same.

Expense Ratio

The higher the expense ratio the lesser are the returns. The high costs will eat up the total returns, reducing the overall return benefit.

So, FMPs with lower expense ratios are preferable over the FMPs with higher expense ratios.

Growth Or Dividend Option

There are two options to choose between while investing in FMPs. They are the growth and dividend options. Investment tenure is the main criteria to choose between these two options.

Growth option is good for long-term investment, that’s most probably more than a year. Because, the capital gains taxed @SST, if the tenure is under 1 year. For more than 1 year tenure period, the investor can be benefited from the long-term capital gains tax rate. Which is @10% without Indexation benefit, and @20% with Indexation benefits.

Dividend option is best for, under one year investment tenure. Under this option returns are in the form of dividends. These dividends are charged by the dividend distribution tax, which is @12. 5% for retail investors.  This, along with education cess and applicable surcharges are paid by the fund. And are tax-free in the hands of individual investors.

Maturity Of  The Scheme And Indexation Benefit

Some of the FMPs launched between January and March every year, offer double-indexation benefit. As the scheme is purchased in one financial year and the matured after two financial years, these schemes are benefited by the double indexation.

Under double indexation, the overall tax liability gets reduced, as the long-term capital gains are adjusted for inflation. That means, for two years the capital gains are adjusted @rate inflation and only the pure capital gains are taxed. Thus, the overall tax liability is reduced.

For example, a scheme is launched in March 2011 i.e. FY10-11, it will mature in April 2013 i.e. FY12-13. While the investment is made in FY10-11, the redemption takes place in FY12-13. Thus, by investing in FMPs with the maturity of a little over a year, the purchase and sale years are spread over two financial years, called double indexation, which effectively reduces one’s tax liability.