13.3 Scheme Selection Based on Investment Strategy
Key Takeaways
- Active management seeks to beat a benchmark; passive management seeks to replicate it.
- Value, growth, quality and momentum are distinct equity styles that lead at different points in a cycle.
- Accrual and duration are the two principal debt strategies.
- Concentrated portfolios raise the dispersion of outcomes in both directions.
- Strategy must match the investor's horizon and tolerance for periods of underperformance.
Active versus Passive
| Active | Passive | |
|---|---|---|
| Objective | Beat the benchmark | Replicate the benchmark |
| Expense ratio | Higher | Much lower; BER capped at 0.90% for index funds and ETFs |
| Success measured by | Alpha, information ratio | Low tracking error |
| Depends on | Manager skill | Execution quality |
| Outcome dispersion | Wide | Narrow, near the index less costs |
The case for passive is strongest where the market segment is efficient and widely researched, so that consistent outperformance is hard, and where the cost difference is large relative to the achievable alpha. Indian large cap is the segment where this argument is most often made.
The case for active is strongest in less efficiently priced segments — mid and small caps, and credit-sensitive debt — where research can genuinely add value, and where an index may include companies a manager would decline to own.
Many portfolios sensibly combine both: passive exposure in the efficient core, active exposure where research plausibly earns its fee.
Equity Styles
| Style | Approach | Leads when |
|---|---|---|
| Value | Buy companies priced below intrinsic worth | Valuations mean-revert; after excesses unwind |
| Growth | Buy companies with high expected earnings growth | Growth is scarce and rewarded |
| Quality | Buy consistent, low-leverage, high-return businesses | Markets are stressed or uncertain |
| Momentum | Buy what has been performing | Trends persist |
| Blend | Combine approaches | Reduces style dependence |
The essential point for a distributor: styles go out of favour for years at a time. A value manager lagging for three years during a growth-led market has not necessarily failed; the style was out of favour. Judging any style-driven manager over less than a full cycle is unreliable.
This is exactly what the Tier 2 benchmark exists to reveal. A value scheme lagging its broad Tier 1 index while beating its Tier 2 value index has handled a difficult style environment well — a conclusion invisible from the headline number alone.
Concentration
| Approach | Characteristics |
|---|---|
| Concentrated — for example a focused fund with up to 30 stocks | Higher conviction; wider dispersion of outcomes in both directions |
| Diversified — 50 to 70 stocks | Smoother; individual selection matters less |
Concentration amplifies both skill and error. It is appropriate for an investor with a long horizon and genuine tolerance for periods of significant underperformance, and inappropriate as a first equity holding.
SEBI's revised categorisation raised the minimum equity allocation for focused schemes to 80% and applies a 50% portfolio overlap cap with other equity schemes of the same AMC for several strategy categories, with monthly overlap disclosure — which makes it possible to check whether a supposedly distinctive scheme genuinely holds something different.
Debt Strategies
| Strategy | Approach | Principal risk |
|---|---|---|
| Accrual | Hold to maturity, earn the coupon | Credit risk |
| Duration | Position duration for expected rate movements | Interest-rate risk |
| Roll-down | Hold a defined maturity profile that shortens over time | Both, in reducing measure |
| Credit | Hold lower-rated paper for higher yield | Credit risk, concentrated |
An accrual strategy suits an investor who wants predictability and can hold to the scheme's maturity profile. A duration strategy is a call on interest rates and produces meaningful volatility; it suits an investor who understands that a long duration fund can fall several percent in a quarter.
The examinable caution: a debt scheme showing a yield to maturity well above its peers is describing its risk, not forecasting its return. The rating profile in the same fact sheet shows whether it comes from credit or from duration.
Matching Strategy to the Investor
| Investor | Suitable strategy |
|---|---|
| First-time equity investor | Diversified active or a broad index fund; avoid concentration and single styles |
| Long horizon, tolerant of underperformance | A style-driven or concentrated scheme is defensible |
| Cost-sensitive, wants market returns | Passive in the efficient core |
| Needs predictable debt returns | Accrual or roll-down, high credit quality |
| Has a view on rates and can bear volatility | Duration strategy, sized appropriately |
Checking That the Strategy Is Actually Being Followed
The stated strategy and the observed portfolio occasionally diverge. Three checks:
- Market-capitalisation split — is a flexi cap scheme genuinely flexible, or effectively a large cap fund?
- Portfolio turnover — does it match the stated approach? A long-term value manager with turnover above 2.0 is not doing what the strategy describes.
- Portfolio overlap — with the AMC's other schemes, now disclosed monthly for several categories. High overlap means the distinctive strategy is not producing a distinctive portfolio.
These take a few minutes with a fact sheet and are far more informative than a performance ranking.
A value-oriented equity scheme has lagged the broad market for three consecutive years. What is the appropriate assessment?
In which market segment is the argument for passive management generally strongest?
Which checks reveal whether a scheme is genuinely following its stated strategy?