Category: Investment Management

How to construct an ideal portfolio

Creating the Perfect Investment Portfolio

Building an optimal investment portfolio is a step-by-step process that begins with establishing an emergency cash reserve and involves key elements like insurance, asset allocation, timely rebalancing, and estate planning. The primary goal is to manage risk while striving to outperform inflation and achieve financial objectives. Part of effective asset allocation includes investments in equities, debt, cash, and gold. However, choosing the right mix of mutual funds often requires guidance from a professional rather than relying solely on luck.

Selecting the best mutual fund doesn't necessarily mean the one with the highest returns but rather the one that aligns with your risk profile, financial goals, and ranks well within its peer group. A common mistake among mutual fund investors is solely focusing on performance, especially recent performance.

Here are some guidelines for evaluating a mutual fund:

Performance Ranking:

Instead of fixating on a fund's recent or long-term performance, consider its ranking compared to its peers. Utilize ratio analysis, including risk and return metrics like standard deviation, Sharpe ratio, Treynor ratio, and Jensen's alpha. The Sharpe ratio, in particular, measures a fund's performance concerning the risk it takes. The higher the Sharpe ratio, the better the fund has performed in relation to the risk.

The Treynor ratio, on the other hand, measures excess return per unit of market risk and is calculated by dividing the portfolio's return minus the risk-free rate by its beta. Beta quantifies the fund's sensitivity to market movements.

Jensen's alpha assesses the manager's ability to generate excess returns for the risk assumed. It can provide insight into the manager's skill.

Total Expense Ratio:

Carefully examine a fund's total expense ratio (TER) as it significantly impacts returns. While SEBI has capped mutual fund TERs, lower expenses are usually preferable unless higher expenses translate into extraordinary returns.

Fund Manager Experience:

The fund manager plays a pivotal role in a fund's performance. Although the process is structured, the fund manager's experience and perspective are crucial. Assess the fund manager's track record and performance across other funds under their management. If there's a recent change in the fund manager, monitor their performance before making hasty decisions.

Scheme Asset Size:

Consider the fund's asset size, as larger assets help mitigate risks related to portfolio turnover and the impact of significant investor withdrawals.

Portfolio Construction:

Crafting an ideal portfolio depends on your risk tolerance, investment horizon, expected returns, and tax implications.

Dilzer Consultants' Fund Selection Methodology:

Dilzer Consultants follows a research methodology to optimize the risk-return trade-off for clients. The process consists of:

  • Asset Allocation
  • Fund Categorization
  • Fund Selection
  • Portfolio Optimization

Asset Allocation Methodology:

Dilzer Consultants employs forward-looking asset allocation strategies based on client risk profiles and market dynamics. The strategic allocation aligns with the client's risk profile, while tactical allocations depend on market dynamics, including valuation and momentum metrics.

Fund Categorization:

Fund categorization is a subset of asset allocation, tailored to client risk profiles. It determines the type of funds suitable for the client's risk tolerance.

Fund Selection Process:

Dilzer Consultants uses a weighted system to evaluate funds based on returns and various ratios, such as standard deviation, Sharpe ratio, Sortino ratio, Treynor ratio, information ratio, Jensen's alpha, R-squared, and beta. Negative attributes like negative count, mean return, and standard deviation are also considered.

Portfolio Optimization:

Once funds are selected, a scientific model, Mean Variance Optimization, helps determine the allocation percentages to build portfolios with optimal risk-return profiles.

Portfolio Presentation:

Regular portfolio fact sheets are provided, offering insights into return attribution, indicating how much of the returns are attributed to asset allocation and scheme selection.

Sneha Ramamurthy Dilzer Consultants Pvt Ltd