In 4 steps to creating a portfolio, we spoke of the need of core holdings.
A core holding is just what it sounds like: It's the central part of your portfolio. The core requires investments that will be reliable year in and year out. They're the solid foundation for the rest of a portfolio. To reach your investment goals, your portfolio needs a solid, reliable core. The rest is often frills.
The core holding concept might not be the most exciting of ideas, but what core holdings lack in thrills, they make up for in importance.
The main primary purpose of such funds is to provide a stable base that does not require much adjustment. The non-core funds can be the more volatile offerings that help boost overall returns.
Let’s look at a portfolio of mutual funds.
The best core options will be large-cap funds. Large-cap funds, which own big companies are core stalwarts. They may not lead performance lists, but they're even less likely to bring up the rear. They're boring, which makes them ideal core choices. Within large-cap funds, there are plenty to choose from. Some are focused only on bluechip stocks, others on the "top 100" stocks by way of market capitalisation, still others will have no such restriction. Some may have a 75% exposure to large caps, others may prefer holding up to 85% in large caps.
For cautious investors, maybe an index fund or an exchange traded fund, or ETF, could be a preferred core holding. But not one that tracks a mid-cap index; stick to the larger indices - there are Nifty ETFs and index funds to choose from. Alternatively, a balanced fund too could be a good fit here.
A flexi cap fund may not have the best temperament for core holdings; they tend to have bigger mood swings than their large-cap counterparts since they have the option of spanning across the market cap in search of opportunities. They could deliver higher returns--but if they are heavy on smaller fare, it could spell bigger losses than you might want at the heart of your portfolio.
What about core stocks?
If you're more into stock investing, your core should be made up of stable, blue-chip companies. As with funds, big and boring is the key to a core investment.
Great core stocks share a handful of qualities. For starters, they're profitable, consistently earning great returns on the money (or capital) shareholders have invested. The way we measure return on capital for companies is return on equity, or ROE. It's easy for a company to generate a large ROE in one year, though. Core holdings offer impressive ROEs year in and year out.
Core stocks are reliable growers. They may not be growing at the same pace that a new company is. But their earnings are predictable year in and year out, and they may even pay out earnings to shareholders in the form of a dividend.
Finally, core companies are also financially healthy. In other words, they don't take on a lot of debt. Moreover, they generate plenty of free cash flow, or cash flow after spending.
Would a medium term debt fund be a good core holding?
It all depends if your asset allocation calls for it. If you already have money in your Employees Provident Fund (EPF), Public Provident Fund (PPF), National Savings Certificate (NSC), bank or company fixed deposits and other such savings, your debt allocation may already be well taken care of. If you do want some debt exposure in your core holdings, opt for a balanced fund that has at least 65% exposure to equity.
How big must your core be?
There's no rule for how large your core ought to be. But we suggest that core holdings take up at least 50% of your portfolio. After all, you are relying on these solid, long-term investments to help you reach your goals.
So where do the rest of your assets go? Into non-core investments, or the supporting players of your portfolio.
Non-core holdings are the stop-and-go investments that may juice returns—sector and thematic funds (infrastructure, FMCG, banking, technology, pharma), and mid-cap and micro-cap funds. A fund with international exposure could also be considered. Once again, check the mandate carefully. Are they focused only on a particular geography such as Latin America or China or the U.S., or are they thematic in their geographical allocation, such as emerging markets' fund. Or they may not be restricted to a geography but to a theme - such as mining stocks, real estate stocks or agriculture stocks. None of these non-core funds should ever corner the bulk of your portfolio.
Use non-core investments for diversification and growth potential. For instance, a core made up exclusively of large-cap funds, would do well to have at least one mid- and small-cap fund in the non-core portion of the portfolio. That would ensure diversification across companies and market caps. Being equity diversified funds, it would also bring exposure to various sectors.
While you probably wouldn't want to put a significant portion of your portfolio in any one of the investments categorised as non-core, they do allow for the possibility of extraordinary returns. Of course, they also generally carry a higher level of risk. But as long as you limit the more risky portion of your portfolio, you aren't likely to threaten the bulk of your nest egg--and your investing will be more adventurous. Just don't forget to put together a reliable core first. You don't want more thrills than your portfolio can stand.