Discover the Secrets to Building a Strong Portfolio with Index Funds | Arun Sundaresan's Guide

0:03 [Music] Hello and welcome to the second episode of the index investor, a series where we address the most frequently asked questions from our viewers about index funds. In today's episode, we'll dive into how to build a strong portfolio using index funds covering everything from asset allocation to rebalancing and how index funds can work for you. Joining us to discuss these practical strategies is Arun Sundares. He's head of ETF at Nepon India Mutual Fund. So stay tuned as we explore the best ways to create a solid diversified portfolio. Welcome Mr. Sundas. Thank you uh Ruchira. Thanks for having me on the show. Great to have you back with us. Now let's start with a question that's on everyone's mind. With so many

0:48 indices to choose from Nifty50, Nex 50, Nifty 500 and many others. How should investors decide which index fund is right for their goals? Uh so uh there are right now nearly 160 indexes unique indexes different indexes on which you have products. This is far more high even when compared to the options you have in the active funds. Right? So this number itself could be overwhelming. So so many funds and in fact these are the unique funds. If you look at the total number of funds as of now it's 560 funds. So that's a whole lot and you know uh uh investors can quite understandably get confused as to where to start. But let me break this up

1:36 for you. Uh within these indices there are only three type of asset classes. So one is equity, second is fixed income and third is commodities. Commodities only two commodities are available which is gold and silver. Now so the asset class becomes very very simple. That's uh the starting point and within each asset class in equity also if you look at it there are only four types of equity funds at at the category level one is what we call as broad-based indexes. So broad-based indexes are diversified indexes but these are market cap based indexes like the popular ones like uh nifty, sensex, midcap, small cap. uh the characteristics of these

2:23 indexes even next 50 or Sensex next 30 all of these indexes the characteristics is the sectors will be all diversified there will be 12 sectors 15 sectors but um the focus will be on the uh size of the companies the larger the size in nifty will have a higher weight and it'll slowly come down the top 100 is considered to be large cap then you have midcap small cap etc so this is one type of index everyone understands this very very simple the second category is sector like for example bank pharma IT you have a specific view about a sector at any point in time rather than figuring out which bank to buy or

3:08 which to sell you simply go and buy the entire index right so that's second the third category is called thematic now thematic is like infrastructure consumption this is again diversified Right? But the theme is very specific here. You may be investing into power, construction, some utility companies, but all of them are infrastructure companies, right? So that's a specific theme you want to play and you can do that within equity. The last and this is a very interesting uh segment within equity where you have again have a plethora of choices what is called as factor-based funds or strategy indexes. So what um these funds do is they focus on specific factors like for example

3:55 value investing or quality stocks momentum whichever stocks are having momentum or those stocks which exhibit low volatility. So you have various of these factors and then you can even combine them. You can combine two factors. You can combine let's say momentum with quality. You can combine alpha with lower volatility and all of those combinations are possible. Right? So these are the four types of equity. Then in fixed income only two types are there. One is constant maturity. Suppose you want to invest into 10-year government security or 5year uh government securities you can do that. So it becomes uh straightforward. The other category is called as target

4:41 maturity fund which is nothing but almost like an equivalent of FD. So when you are investing right now, you go and invest into let's say a 2028 maturing security or a 2030 maturing security and you will typically buy and hold. So it's as good as you buying a 3-year bond or a 5year bond. It could be government securities or state loans or in passives only AAA corporate bonds are allowed right now. The highest grade, right? You just go and buy that. provided there is no default you're going to get whatever yield you bought uh till till the time you hold on. So at the at the broader level these are the three categories right and in India unlike in the western world we don't have any exotic uh

5:28 passive products like leveraged products or inverse ETFs and you don't have all that all the funds have to 100% replicate. So if this understanding becomes uh clear and becomes very simple. Now you're left with uh the fundamentals of investing you start with asset allocation saying how much should I invest into equity fixed income and to some extent even in gold and stuff like that. Uh and there there is no thumb rule. So how muchever you know uh podcast we do different people talk about it. Some people give thumb rule like you know 72 minus your age should be this and that and so many things. Let me tell you there is no hard and fast rule. There is no thumb rule. See for example traditional um understanding

6:14 would be that somebody who's retired will be less risk coververs. He should invest mostly in fixed income if not completely right because his other source of income could have dropped or not there and then he's dependent on that. So if that is the case fine but there could be some retirees who could be very very wealthy they may not need that part of the investment corpus for the next 3 years 5 years or 10 years so the purpose could be different so therefore I think investors should refrain from general thumb rules they'll have to think about their unique circumstances in general longer the time horizon that somebody has whether it is closer to retirement or at the time of

7:01 working uh you will invest into slightly more risk assets like equity for example I'm a salaried professional I'm earning I I have net savings month on month and this money I wouldn't need for the next 5 years 10 years this is meant for the longer term I would predominantly invest that into equity on the other hand if I need a regular income I'm dependent on that suppose for whatever purpose like uh I'm retired or whatever it is uh a larger part should go to fixed income. So investor should think hard about this and this is a very critical decision point as to how much there are a lot of studies which shows that asset allocation is what makes uh which explains much of your returns rest of it

7:47 you know you keep moving here there active passive all of that will make a difference but you know they are not as important as this decision of asset allocation. So you get that right. You decide how much to invest into equity, fixed income and within that we talked about various asset classes and then you can decide and within equity generally again there is no thumb rule. People have take this approach of core and satellite the core portfolio they build using market cap which is broad-based indexes like for example nifty midcap. So usually a bulk of the equity portfolio will be that and time to time as a satellite portfolio they would add some bit of a sector exposure here or thematic exposure there or if they like

8:34 a particular strategy they've understood that they find that it's very interesting maybe you know some bit there etc. But uh um having mentioned about all these things, choices are there. If you break this out into know simple terms like this and then start getting into slight details, uh it's very easy. Right now, here's another important question. Can index funds be enough to meet long-term goals like retirement or children's education? Or should investors still look to active funds and other products to, you know, round out their strategy? In uh my opinion uh both you know either you choose to invest 100% in passive or 100% in active or some combination doesn't matter it

9:21 will still help you as I said for example if the question is suppose you choose only passive and to meet your various goals including retirement my sense is it will because end of the day what is it doing it is investing in the market and here we're talking about investing in any part of the market. If you want to be within equity relatively aggressive, go for midcap. A little more of midcap and small cap than large cap. Right? Within strategy indexes, for example, a strategy like low volatility is far more or far less risky than when compared to momentum both in terms of risk as well as in return. So with an equity if you want to play it relatively conservative you could choose a low

10:07 volatility kind of a product on the other hand if you want to be aggressive then you choose something like a alpha or a momentum. So therefore within passives itself there are plenty of strategies funds to choose from which will help you meet various investment goals. It could be near-term like you know 1 year 3 year for example if you say that my goal is for the next one year. So we would recommend a one-year target maturity fund where returns will not be high but you will have visibility of that return right so you can meet that requirement through passive on the other hand if you say that look you know I'm 35 or 40 I have 20 more years to retire is a very long-term to start with you invest a lot of money into equity

10:54 build that corpus and then closer to retirement maybe you reduce that exposure to equity and start adding a little more of fixed fixed income and all that. Uh and while doing it, these are all investments in funds, right? Equity, fixed income. You can also combine this with various modes of investing. For example, you can systematically invest. Instead of investing lumpsum every month, you can invest some amount at the same time after retirement or if you want regular income, you can systematically withdraw. We call it SWP, systematic withdrawal plan. You can do that. So by doing a combination of all that, choosing which kind of funds to invest and combining them with various features like SIP, SWP, you can actually um you know kind

11:40 of figure out your cash flows as to how exactly you want. So in my opinion even in passives you will be able to build the entire portfolio for various purposes and even the other way around. So somebody has a very strong preference for active so be it. So you can choose you know so as I said um that should not be a starting point active or passive or how much of active and passive more importantly they should go with uh they should evaluate each of those strategies for its merit and see you know how it fits in right but uh Mr. Sundar whatever said and done we often hear a lot about equity indexing but not so much about uh passive debt funds. So while you did mention that there are two kinds of uh

12:26 you know fixed income passive funds one that are constant maturity and then the other ones that are target maturity funds. So if you would elaborate how passive debt funds fit into a well diversified portfolio. Okay. So um a debt investing is about investing in bonds right. So you can choose different types of bonds either government securities or bonds issued by state governments. These are called SDL, state development loans or you can invest in bonds issued by corporates and they come in different variety uh and depending on the risk and return potential it could be you know having different ratings depending on the uh risk of that particular bond like AAA double A plus

13:11 double A etc. But as of now in the passive space only AAA bonds are allowed. So uh so this becomes asset class. within fixed income suppose you have a very strong inclination liking to invest only in government securities bond I do not even want to invest in AAA corporate bonds you have options you will have you know funds uh for that right so this is one and then the other important element in um fixed income investing is the what we technically call as maturity or duration suppose you invest into a one-year bond and visa v an investment ment into a 10-year bond. The movement of the bond, the price movement of the bond based on interest rate movement will be different. Longer

13:59 the bond, higher will be the risk and return. the interim movement will be so depending on that suppose you feel that okay I'm investing uh I feel that there is a interest rate cut that is going to come that would help my returns then you will invest slightly long you will invest into longdated bonds visa v short-term and vice versa you will you will keep doing that so this is like you know choosing a particular tenure like and at any point in time the tenure could be more or less that like um there is a product called you know 8 to 13 a government security uh uh ETF index fund. So at any point in time the investments will be into those securities you get that constant uh maturity right. So this is one and what

14:44 you get is a duration impact you get you know you're investing into a in this case a 10-year bond or uh around that right the other type of um investing is that it's like you go and buy an FD right a three-year FD in a bank uh although that's not the exact right comparison right here you go and buy a three-year bond suppose there is a three-year government of India bond uh which Today is let's say trading at for example 6.5%. Right now if I go and buy this bond today and this is yielding me 6.5 and government bond will not default if I hold till 3 years I will get 6.5 right. So that's the concept. So you go

15:30 and buy and hold till maturity and of course you know after 1 year or 2 years if you want to sell you can sell but that will be at the market price depending on how the interest rates are moved. That's a that's a different phenomena. But uh here is an option for you to actually go and buy a three-year bond or a three-year fund. And if you want to stay put for the 3 years, you get more or less that kind of heat. Of course, there'll be some you know coupon reinvestment and you know few things are slightly technical but by and large you will get you know that kind of this thing. So it becomes very simple right? So you don't have access to or generally a lot of investors will not go and buy bonds directly. Here you can buy a portfolio of bonds through a passive fund and in this case you are

16:15 targeting a specific maturity like 3 years and there are even products for very long term. There is a product for 2036 maturity. Suppose you know you want 10 years this thing. Suppose you're approaching your retirement. You're 50 years of age and by 60 you will retire. So you are targeting a specific um corpus between now and the next 10 years with more or less certainty right uh with this money even though it's long-term you may not want to invest in equity for whatever you do not want to take that kind of equity risk and say that look let me invest into a bond and this bond is giving me 6.5 or 7 so for 10 years my money will become double I'm happy with that you know so that's exactly what I'm looking for and you go and invest Okay.

17:02 Right now, lastly, let's talk about rebalancing. So, how often should one adjust a portfolio made entirely out of index funds and how should one do it manually or are there automated solutions that can make it easier? Yeah. See, all index funds by definition are rules based and as part of the rules, they also have a rebalancing frequency. For example, if you take a momentum index fund, right? So the momentum scores will be checked every 6 months. Every 6 months and whichever stock is coming in the uh uh based on the method whichever stock is coming into the portfolio those stocks will come in and the others will go out the change it keep on happening. So if the concern is

17:50 that my portfolio should reflect the underlying philosophy that happens all the time. It happens it's a ongoing process. It's very very continuous. So you can be rest assured that I have chosen to invest into a momentum strategy now and it's going to be like that and the portfolio automatically does that adjustment over a period of time right so same with nifty and sensex or anything nifty is what 50 stocks right the top 50 stocks the top 50 stocks are not the same constant all the time a few stocks uh will move out a few stocks will become larger and become the top 50 stocks so that automatically happens to meet your requirement of investing into top 50 stocks right so that part is happening but the other

18:35 part in terms of uh you making adjustment you know that is up to you and that will depend on your uh unique requirement see for example to start with let's say that you know I'm a very aggressive investor I wanted to invest 80% in equity 20% in fixed income but over a period of time I'm aging my um you know requirements are changing uh I don't have that many long more uh number of you know salaried years or something so over a period of time let's say I want to reduce my equity exposure from 80 to let's say 60 and get fixed income from 20 to 40 these things you can do by mixing these features that I mentioned

19:21 like SWP so you make a these things can be automated you can set this up up front saying that look today I'm 40 okay I'll keep investing after I reach 50 I want to know money to move out steadily systematically from equity to fixed income I don't have to do anything automatically I'll give this instruction and money will start moving out so that my targeted maybe 60 40 allocation at that point in time can be achieved so these kind of solutions can be built with features And this can be done either automatically. You can set this up right now or at any point in time. So you make an investment now and then say

20:07 that okay let me not do anything at 50 I will review that when I reach 50 years of age at that point in time I will redeem or I'll move some money from equity uh and put that money in fixed income so that my original 8020 now has become 6040. So you can do that at any point in time. So I think you know that's how you'll have to go about it and again this is not specific to passive or active and these kind of strategies can be done with any type of investments to meet your various specific objectives. Right. Well with that it's a wrap on today's episode of the index investor. A big thank you to Mr. Sundar for sharing your insights. Thank you very much.