Last week we launched Investment Packs on Paytm Money app to solve the crucial problem of identifying the right combination of mutual fund schemes that are best suited for your risk taking ability. In this blog, we will explain the detailed process that went behind building these packs in a step-by-step manner.
Basically, it’s a 3-step process:
1. Investor Risk Assessment
2. Suitable Asset Allocation
3. Fund Selection
First two processes are shown below.
Investor Risk Assessment
Taking Risk Assessment to determine your risk profile is the first step into the world of investing. It helps you understand your risk profile by combining your willingness to take risk as well as your ability to take risk with your money. This is gauged based on your response to a few questions about your age, income, assets and liabilities, investment time frame and so on. Your risk profile would then be mapped to one of the following:
- Low Risk Investor
- Conservative Investor
- Moderate Investor
- Growth Investor
- Aggressive Investor
Suitable Asset Allocation
Your asset allocation is then decided based on your risk profile. Remember, doing proper asset allocation based on your risk profile and then choosing the right funds are equally important for achieving your financial goals. That’s precisely what Investment Packs do!
Major asset classes used are equity and debt. These two asset classes have a distinct risk-return profile and most importantly have a low degree of correlation. This feature provides us with the chance to diversify away some of the risk when we construct an investment pack containing both these asset classes. The asset allocation between equity and debt is determined after keeping in mind the investor risk profile.
An ‘Aggressive investor’ as shown above would be having maximum exposure to equity asset class to match his / her risk profile which is inclined towards higher returns at high risk over longer period of time . The ‘Low Risk’ investor, at the other end of the risk profile spectrum has maximum exposure to debt asset class naturally as he / she is looking for very stable returns with low volatility linked to markets.
Once the asset allocation is decided for each risk profile, appropriate equity and debt mutual funds are chosen to construct each investment pack. The methodology to choose individual funds is given below.
While choosing funds for investment packs, first we apply basic filters on the universe of mutual funds by selecting only the following categories:
- Active funds (Schemes that are actively managed)
- Open ended funds (Schemes that are accepting fresh investments)
- Direct funds (Schemes that give higher returns due to no commissions, hence lower expense ratios)
- Growth funds (Schemes that are suitable for long term wealth creation)
Post these filters, we arrive at a subset of mutual funds that we would like to choose from. We further remove funds that can skew our analysis by putting a filter to choose funds having:
- Reasonable assets under management (AUM) (To protect investors from sudden redemption impact)
- More than 3 years of history (So that only funds with consistent performance are picked)
Equity Fund Selection Methodology
The available set of equity funds is divided into respective categories and evaluated within each category based on parameters mentioned below. The goal is to choose funds that provide superior risk adjusted returns on a consistent basis.
- Information Ratio, which measures a portfolio manager’s ability to generate excess returns relative to a benchmark on a consistent basis
- Sortino Ratio, which evaluates an investment’s return for a given level of downside risk i.e. volatility of negative returns
- Alpha that the fund has generated, i.e. excess return relative to the benchmark.
- Consistency of fund performance among the peer group historically
- Portfolio concentration in terms of sectors and stocks
- Fund manager
Debt Fund Selection Methodology
Like equity, the available set of debt funds is divided into respective categories and evaluated within each category based on parameters mentioned below. The goal is to choose funds that provide stable and consistent returns without taking excess risk.
- Yield to Maturity, which is the total return expected from a fund if it is held till maturity
- Modified Duration, which indicates the interest rate sensitivity of the fund
- Credit Quality to see how much risk the fund is carrying
- Expense Ratio
- Assets under management (AUM) of the fund
- Portfolio concentration in terms of sectors and companies
- Fund manager
Hence, through the 3-step process mentioned above, investment packs have been created for each risk profile based on suitable asset allocation for the investor’s risk taking ability. Each risk profile has 2 dedicated investment packs, based on the minimum investment amount:
- Large Investment Pack having minimum investment amount of Rs. 5,000
- Mini Investment Pack having minimum investment amount of Rs. 2,000
Additionally, we have created a tax saver pack using ELSS funds so that an investor can save tax as well as grow his wealth by choosing the best funds. Details about the construct of each pack and their historic returns will be discussed in a separate blog post. Stay tuned.
To invest in Investment Packs, access them on our app.
Let us know in the comments below what you think about this feature & don’t hesitate to share feedback. Your inputs are what help us improve.
Disclaimer: Mutual Fund investments are subject to market risks, read all scheme related documents carefully. Past performance is not an indicator of future returns.