Gold bars and tools sit on a work bench at a jewellery workshop in Pune, India. (Photographer: Dhiraj Singh/Bloomberg)
Gold bars and tools sit on a work bench at a jewellery workshop in Pune, India. (Photographer: Dhiraj Singh/Bloomberg)

The Mutual Fund Show: A Simple Strategy For The DIY Investor

A minimalist approach to investing may be good, more so when a crisis like the Covid-19 pandemic cause turmoil worldwide. But it isn't easy, especially for a do-it-yourself mutual fund investor, when a myriad of debt and equity choices are available.

A DIY investor must have one domestic equity mutual fund, one overseas fund, an exchange traded fund and one government security or liquid fund in their portfolio to enjoy the benefits of asset allocation, said Pratik Oswal, head of passive funds at Motilal Oswal Asset Management Company, on this week’s The Mutual Fund Show. This strategy, according to him, helps eliminate manager, sector, size, geography and credit risks.

Around 90% of long-term investment objectives are aided more by right asset allocation than fund selection, Oswal said. He suggested investors must have just one Nifty 500 index fund—which encapsulates 96% of Indian equities—in their DIY portfolio.

Suresh Sadagopan, founder of Ladder7 Financial Advisories, while agreeing that investing in more than 5-7 mutual funds in one’s portfolio “creates chaos”, said having just one Nifty 500 fund isn’t akin to “glove fitting the hand perfectly” strategy. The passive fund strategy may be viable for large cap funds but, he said, investors must examine active small and mid-cap funds.

Nifty 500 index funds, according to a Motilal Oswal presentation, would return gains to investors over longer time periods, or around 15 years, that are in line with that of “moderate growth + gold” strategy and outperform the “conservative growth + gold” strategy.

The moderate strategy would have 60% allocation to equities—which comprises a domestic fund and an international fund. The remainder will be in debt and gold, not exceeding 5-10%. The conservative strategy would have 50-60% of the overall portfolio in debt.

Watch the full show here:

Here are the edited excerpts from the interview:

The sceptic would say and I would expect Pratik Oswal to anyway say that because he heads the passive investment at Motilal Oswal, so why wouldn’t he be in favour of minimalism and passive investing?

Oswal: I think this comes from more about concern than anything else today. There is a lot of complexity in the marketplace today. There are thousands of mutual funds, hundreds of debt funds and even the categories, you’ll be caught up in a very big way. The idea behind this approach is to actually keep things very simple. There’s a saying the less you have, the less you have to worry about. I think that is what is all about minimalistic investing. In fact, what the data shows, and Harry Markowitz, a Nobel Prize winner in economic sciences, said a portfolio doesn’t really need more than 30 stocks. I think the benefits of diversification stop after the 35th or the 40th stock. So, the idea behind this is that you don’t actually need 5 or 6 to 10 to 15 mutual funds. Because today, the concern is that a lot of people are holding a lot of mutual funds. I have spoken to an investor who has over 50 mutual funds. So that is something which really needs to be looked at. Also, because you have so many funds, the problem is that the investor looking at a 10-year perspective is checking his NAVs every day. He also tends to chase returns a lot which is what I think is a big concern in the industry as well. So, I think here this concept of minimalism comes in.

Ideally, what I’m saying is that a DIY (do-it-yourself) investor today should be okay with one equity mutual fund in India, one abroad, maybe one gold ETF and probably one G-Sec or one liquid fund. That is good enough for him to have on an asset allocation basis.

I was looking at the presentation that you made and I would urge you to take us through those numbers as well. The combination of the strategies and the return profile because in 5-10 or 15 years, I think, you guys have gotten the returns of the Nifty 500 TR Index, growth plus gold, a moderate and a conservative and an income strategy. Can you take us through that?

Oswal: I think today asset allocation has become a gold standard of investing. That’s because asset allocation is actually the antonym or the opposite of market timing. The whole idea is to spread your bets in multiple asset classes because you don’t know what will do when. So I think the reason why I say asset allocation works is because people realised over the last four or five decades that market timing does not work. Which is why I think, and at least what the data shows, is that your 90% or maybe close to 90% of long-term objectives of investing comes via asset allocation and less with fund selection, which is why we’ve kept fund selection easy.

If you look at some of our presentations you can see that we’ve chosen four asset classes. We’ve chosen one Nifty 500 fund, which basically captures the entire India’s market, 96% of India’s equities is in just one fund. We’ve taken S&P 500, which is a pretty good broad-based equity fund. It’s also a very global fund because most of its sales are coming from operations outside the U.S. For the debt side, I’ve taken the Crisil 10-Year Gilt, just to keep it super simple. Yes it might be a little bit risky at this point in time because yields are pretty low, but I think from a long-term perspective, it’s a pretty good index. For gold, I think gold is actually a pretty interesting asset class. It’s done pretty well but I do think that it is actually a great hedge for when equity does badly. Whenever equity does badly, for the last 15-20 years, gold has done well.

So, when you’re looking at these four asset classes for a typical investor through the mutual fund route, what is the percentage allocation? Is there a standard or is it very individualistic?

Oswal: Ideally the way I see it, there are typically two types of investors—aggressive and conservative. I do think that everyone should invest based on their risk profile and a lot of people will not be able to take it, especially when looking at the current times. With regards to gold, I’m also a huge profit fan, so I do think gold is a non-productive asset class, but I also think that in terms of returns, we have to look at it from a long term perspective. It hasn’t really done that well but I think it’s more of a volatility hedge.

I think a growth investor would have a lot more allocation toward equity. So, maybe a growth investor would have close to 60-80% of his investing in equity, whereas a conservative investor would have close to maybe 50-60% in debt.

I think it’s also important to understand that rebalancing is extremely important and that is where discipline comes in. So, ideally most investors tend to become conservative during bad times and aggressive during good times. That does not work for the strategy. Ideally, most investors today are looking to become conservative but I think the problem is that it’s too late. You’re basically buying insurance after your house is on fire. So I think it’s important to have an allocation and stick to it for bulls and bear markets.

What are you trying to say or what are you trying to depict when you are putting out this risk return profile on the strategy’s front? There is a Nifty 500 TR Index and a five-year, 10-year, 15-year return versus growth plus gold or a moderate growth plus gold. Can you kind of explain this?

Oswal: If you look at the returns of this asset allocation, I think the returns have been actually pretty good. If you’re looking at the growth investor, you are looking at upwards of 13-14% and this is also on a rolling basis, which I think is extremely important that takes out market timing in a big way. A conservative investor can expect anywhere between 10 and 11%, which I guess is very good if you consider that you’re holding a lot less in equity. I think the most important bit here is to compare the Nifty 500, a pure equity fund with both of our portfolios — the moderate growth as well as conservative. Just to give you an example, the minimums go down dramatically. So, if you look at some of the minimum and maximum between the Nifty, you can actually go down 8% or you can go up 67%—that comes down a lot with asset allocated portfolios. In fact, with the conservative portfolio, if you look at it from investing on a three-year basis, what we’ve seen is that there’s zero possibility of you making a loss if you’re a conservative investor. If you are a growth investor, there is maybe out of 4,000 different scenarios, I think around 200 cases where you will make a slight loss, otherwise you’re making positive returns, versus I think the Nifty pure equity product where it goes up 10 times.

And all of these are mutual fund-backed returns? These are not essentially direct equity based investing but are happening by use of mutual funds?

Oswal: Yes, all four are mutual funds. Obviously the underlying data that we’ve used is the index data, but an investor can expect to replicate similar performance by using this minimalistic approach.

Suresh, correct me if I’m wrong, but when you advise your clients—the fees essentially is a fixed fee annually and therefore, it doesn’t matter if the client is investing in a direct portfolio or through an advisor-based or non-direct portfolio. In fact, in your advices you’d actually be telling people to go in for direct plans because your compensations are anyway not linked to investments happening through you.

Sadagopan: You’re absolutely right but there is a small correction. There is not always necessarily a fixed amount of fee. It can be asset under advice basis fee, but the second part of what you said was absolutely right. I mean, we choose monthly commission-free products. So in case of mutual funds, it is purely direct funds and even in other products it will be commissione-free products. So we are basically product agnostic, and we suggest funds based on what is good from the client point of view. It’s purely client-centric, unbiased kind of an advice that we offer. So from our point of view, whether they’re investing in equity or debt or gold or anything is absolutely one and the same. We are not affected in any way.

Pratik Oswal is saying go out on a minimalist approach to investing even in mutual funds because there’s just too much noise and choice out there, and maybe keeping it simple might be better for the head as well and for the portfolio. What are your thoughts here?

Sadagopan: I absolutely agree with Pratik. See, whether it is active or passive, keeping a small portfolio of maybe 8 or 10, including equity, debt is always a good idea, unless you have a portfolio which is ahead of maybe five crore or seven crore. So, maybe the number of schemes may be slightly more. I would not probably go only with one passive and one index fund. I would probably diversify the fund manager risk, I may probably go only for passive as for the large-cap portions of the index are concerned. And I think there is still some juice left in mid cap and small cap, probably for some more time to come but later on again, probably there will be a case for passive maybe a few years down the line. Currently, I will go for actively managed funds as far as mid and small caps are concerned. As far as the Nifty 500 is concerned, I think again, that’s a wonderful product because it captures the entire market and the entire wisdom of the market is actually incorporated in this kind of a passive fund.

Overall equity, debt in a typical portfolio—anywhere between 6 and 10 is what I would suggest. A good diversification can be achieved by just 6-10 funds, both active and passive put together is what I would normally go for.

Suresh, as far as the Nifty 500 is concerned, what are the products available because I know Motilal Oswal as a house has a product like that. Are there other products available in the market as well, if indeed Nifty 500-based investing is a good passive investing product?

Sadagopan: I’m currently not even aware of any other product which is as a fund of fund or a direct index fund. We don’t want to actually put money into ETFs. We have tried doing that. There are challenges as far as the ETF investing is concerned. The first among them is, the client has to have a demat account and many of them do not want to open a demat account just for investing in ETF. And there is also availability of the product at a certain price. I mean the ETF, though it is putting in a particular NAV, it may or may not be available at that NAV depending on the demand. So we found that index is a better product and as far as index products are concerned, the counter party is a mutual fund and from liquidity perspective, liquidity is always available as far as the index fund is concerned. So we would prefer the index fund route and currently we are suggesting their funds only because that is the only fund which I’m aware of which is currently available in index route.

Pratik, there are various schools of thought. There are some people who believe that there should be a lot of funds, some people like Suresh are saying that they are doing a mix even within the equity piece wherein they’re doing maybe a large cap fund which is passive and mid cap and small cap which is actively managed. You are saying that in your equity investing, Indian equity investment product, you’re happy with this one category of fund and which is this Nifty 500 fund. Am I getting it correct, Pratik?

Oswal: I’m not debating on what is better and what is worse. Both are very different strategies. Both work for different types of people. I am talking about an alternative strategy which also works well and if you look at the Nifty 500, it is a combination of large cap, mid cap and small cap. It has been 80% large cap, maybe 15% mid and 5% small. So I think you’re getting some of that diversification there as well but this is an alternative approach. I think this is only for someone who’s not looking at trying to select from the hundreds of mid - and small-cap funds. I think that this probably works better for the DIY investor who doesn’t really have that much access to good quality advice. For him, it would be maybe an alternative strategy more than anything else.

Suresh, the arguments are stacked up in favour of having a smaller portfolio of funds are well known. There are people who believe, as Jack Bogle probably said and please correct me if I’ve gotten him wrong, that if a fund has outperformed for 20 years, sell that fund because the next 20 years it will not work well. There is no rule that the past performer funds will continue to do well. Diversify your portfolio because you do not know which fund in a given year will do well and if want to hold your funds for let’s say 10 years, you can’t definitely say that an X house’s X Fund will do well. So why not diversify a lot more?

Sadagopan: Before selecting a fund you will have to do your homework, especially if you’re choosing an active fund. In the case of a passive fund, there is no homework. I completely agree with Pratik. It is going to give a market determined return and it is essentially capturing the wisdom of the market. So, like he said if you are a DIY investor, having a Nifty 500 is a good strategy. Even in our case, we have Nifty 500 as part of our portfolio for certain conservative investors where we do not want to give mid-cap and small-cap funds. So in a sense, we are giving large-cap exposure and a flavour of mid- and small-cap exposure through the market itself. So now diversification is concerned, we have to keep it at a certain level because as per research it shows that beyond five, six or seven funds in a portfolio, there is no diversification, there is only more and more chaos which comes into play. And it does not add to any kind of risk diversification. So I would stay with a judicious mix of active, passive or whatever else is required in a client’s portfolio, including debt, international funds but not diversified too much.

Pratik, there is a combination of strategies and the return profile that you guys have calculated. And if I read it correctly, on a five-year, 10-year, 15-year period, a moderate growth plus gold strategy works out well. I’m making a couple of assumptions that there is a viewer out here who is a DIY investor, who is watching the show right now. And let’s say that he’s in favour of moderate growth plus gold strategy because it has given decent returns, if history is to be believed. Now for that kind of an investor, I’m trying to marry your initial asset allocation strategy, which is domestic equity, international equity, debt plus gold through funds route. Is there a standard percentage allocation that you would probably allocate 50% to the Nifty 500 index, maybe 20% or 10% to the international S&P 500 index, so on so forth? Is there a standard rule or again it depends upon individual investors?

Oswal: No, we’ve done a 60-40 standard moderate. So, 60% will be in equity and that will be a combination of say a domestic fund which is the Nifty 500 and the S&P 500, and the 40 will be mostly debt and gold. Maybe gold will be a 5-10% allocation. So, that’s how we’ve basically taken it. What’s really important is the rebalancing. This is where most people get it wrong. Most investors try to do the opposite, when markets are bad they tend to sell equity and buy debt. That is the opposite approach of what rebalancing means. You have to make sure that your 50-60% allocation is sustained for a very long time and you rebalance it every year or every half year or so. That’s how I would say asset allocation really works with investors and why it’s important to continue to do it across market cycles.

What are the risks to such a strategy, Pratik? Obviously, the return numbers show that it is all hunky-dory, but any risks?

Oswal: In terms of risk, I think the biggest risk is behavioural. When investing, 90% of psychology and getting it right in terms of strategy. For example, in 2009 when your equity portfolio was down 50-60% and when you had to rebalance a portfolio, which means you’re actually selling debt and buying equity, that is a very hard thing to do. Even in today’s market, ideally customers are better off buying equity and selling debt, whereas most people are doing actually the opposite. So, I think that psychology aspect is what’s extremely important. I do think that investors left on their own do get this rebalancing thing wrong. This is a big risk and if this is not done well, will lead to a strategy not working out.

The whole idea behind this asset allocation strategy is to remove risk... It removes manager risk, removes sector risk, size risk, geographical risk, also credit risk using G-Secs.

I think the whole idea behind this is actually removing risk in your portfolio and all of this is being done with a very low cost which is removing some sort of fee element as well. So, I think, overall, that is what the highlight of this portfolio is. The idea is more de-risking than risking.

Suresh, for people who don’t have the time, they are working and they don’t have the time to take these calls of switching between equity and debt, should they maybe also look at a balanced advantage category, wherein the fund manager will take the call of equity and debt?

Sadagopan: So, for a ‘do-it-yourself’ investor or a conservative investor, they can actually rely on index based funds, especially if they want to do it themselves or the strategy which Pratik had outlined. That is a brilliant strategy. Now as far as rebalancing is concerned, a do-it-yourself investor may not have it in them to rebalance at a point when the market is fairly down. I would say at the minimum, what such an investor should do is at least not at the portfolio and not take out the equity. The ideal thing like Pratik also had shared is to sell debt; sell other things and bring more into equity because the equity allocation would have gone down and you want to rebalance and bring equity back to the previous level. But if you are not able to do that, I would say in a situation like this, don’t allow your psychology to undo your portfolio, stay put at least that’s what I would suggest to investors even if they are not rebalancing the whole portfolio. Otherwise for a do-it-yourself kind of an investor is actually well off with more of a passive strategy, and it’s like what Pratik has because that actually takes care of everything that is required for an investor. It may not be absolutely fitting a person like a glove, for which you will require an adviser but it is largely there. So, it is not a bad thing at all from an investor point of view.

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