ncial Education

Portfolio Strategy using Mutual

Fund
Portfolio Strategy using Mutual Fund

When an investor invests his entire investment corpus in lump sum or at a single go, his
amount is then subjected to market risk. If the investor invests in an ongoing stock market
rally and has no knowledge to evaluate the market at current juncture, then the investor has
timed the market himself and does face the risk of fall in value of his investment if
unfortunately he has invested at the peak of the market rally.

At the top, markets are short lived and bound to fall due to overvaluation. The correction
could be mild or could be severe depending upon the phase of market cycle. So in this
situation the investor must have good financial market knowledge to make rational
investment decision or needs to employ a financial market expert or advisor who could
guide the investor in deploying his total investment amount.

Mutual funds are institution where they create a portfolio of securities and present it to
investors. The portfolio carries low security risk as this risk is reduced by means of
diversification which is holding of various securities from varying sectors, however these
portfolios do not reduce the market risk and are subjected to large swings with respect to
market movements. That is why in any mutual funds disclaimer, they clarify before itself
that their fund schemes are subjected to market risk and investor need to read the red
hearing prospectus properly before investing in them.
However, the best time to invest your lump sum amount is when markets are in tear and
falling sharply and showing negative return by more than 10% on year on year basis. As
markets are cyclical in nature and market fall are usually short-lived for few years or so
because the government and the central bank together takes strong measures to revive the
sentiment of the market and turn up the economic cycle. But it takes a lot of guts and
patience for an investor to invest during weak market environment.

On the other hand, market risk can be reduced by using derivatives which is another set of
complex instrument and mainly used by professionals. Mutual fund managers are not
allowed to use them due to regulations. So the safest option available for general investors
to invest in mutual fund schemes is through systematic investment planning.

Systematic transactions

Transactions with mutual funds can be automated by signing for the facility of systematic
transactions offered by mutual funds. This way they don’t have to worry about the period of
their investments, its redemption etc.

The mutual fund will periodically execute the systematic transactions as directed by the
investor. Following details are to be specified:

Type of transaction: Purchases, redemptions, transfers.

Period: Length of time for which the transactions will run, say one year.
Periodicity of transactions: The frequency of transactions, say monthly, quarterly, half
yearly.
Day of transaction: the day of the month on which each transaction will be executed, say
15th of the month.
Amount: For each transaction and the total amount intended to be invested over a defined
period.
The types of systematic transactions include:

Systematic Investment Plans (SIPs): SIPs enable investors to invest a fixed sum
periodically into a mutual fund scheme. Investing in SIP enables an investor to take part in
the stock markets without actively timing them and investor can benefit by buying more
units when the price falls and less units when the price rises. This scheme helps reduce the
average cost per unit of investment through a method called Rupee Cost Averaging. A
person invests Rs 1000 for ten months in SIP. We will find out that the actual average
purchase cost of asset would be lower than the average NAV of his investment over 10
months, which is the key benefit of Rupee Cost Averaging.
NAV Average in mutual funds

Actual average purchase cost as per SIP = (1000X10)/

(100+200+67+71+67+50+45+40+37+34) = 14.06.

which is lower than the average NAV i.e 18.2.

Since SIP investor is a regular investor, its investment fetches more units when the price is
low and lesser when the price is high. During volatile period, it may allow one to achieve a
lower average cost per unit.

Systematic Withdrawal plan: SWPs allow investors to make periodic redemptions from their
existing mutual fund investments at the prevailing NAV related price. For Example:

Investor have 8,000 units in a MF scheme. Investor can give instructions to the fund house
to withdraw Rs. 5,000 every month through SWP.
On 1 January, the NAV of the scheme is Rs. 10.
Equivalent number of MF units : Rs. 5,000/Rs. 10 = 500
500 units would be redeemed and Rs. 5,000 would be given to the investor.
Remaining units : 7500
Now, on 1 February, the NAV is Rs. 15. Thus, Equivalent number of units = Rs. 5000/Rs. 15 =
333
333 units would be redeemed from investor’s MF holdings, and Rs. 5,000 would be given to
the investor.
Investor’s remaining units = 7500 – 333 = 7167
And so this process continues till the time investor wishes to withdraw. A statement of
accounts showing the details of the transactions done, the balance units and their value will
be sent every quarter.

Systematic Transfer Plans (STP’s): STPs permit investors to periodically transfer a

specified sum from one scheme to another within the same fund house. The transfer is
considered as redemption from the scheme from which transfer is made (source scheme)
and investment into the scheme in which the redemption proceeds are invested (destination
scheme). This help investors save the effort and time by compressing multiple instructions
required for redemption from one scheme to invest in the other, into a single instruction. For
example:

An investor starts a monthly STP from a liquid fund to an equity fund over a six month
period starting from 5th September 2014 for an amount of Rs. 10,000.
The source scheme is the liquid fund and the destination scheme is the equity fund.
On the 5th of September, Rs. 10,000 worth of units will be redeemed from the liquid fund at
the NAV prevailing on that date.
NAV has to be adjusted for exit loads, if applicable.
On the same date the amount will be invested in the equity fund at the NAV of the fund.
The number of units redeemed from the liquid fund and the number of units bought in the
equity fund will not be the same each month but will depend upon the NAV prevailing at the
time in each scheme.
The STP will stop at the end of six months.
The holding in the liquid fund would have reduced over the period and the holding in the
equity fund would have increased.
A statement of account giving the details of the transactions done and the unit balances
and value will be sent to the investor every quarter.
Switches: Switch is redemption and a purchase transaction rolled into one and can be done
for any amount and on any date as required by the investor. Switch is a single transaction
executed on a given date and is not a series of transactions. The destination or target
scheme is the scheme into which money is switched in to purchase new units. Switch can
also be done from one option to another. For example, an investor who has chosen a growth
option can switch to a dividend option. On the date of the submission of the switch request,
the amount will be redeemed from the existing scheme at the applicable NAV after
considering loads. Redemption amount will be invested into the new scheme at the current
NAV. A statement of account will be sent giving details of the transaction.