The Hindu Business Line : Avoid over-diversification

Amit, an avid investor in equity mutual funds, claims with great pride to his friend Yogesh that he has invested in 50- odd equity oriented schemes till date and this is the 51st investment.

He further boasts that he plans to take the number to 80 by the end of the year. Yogesh is surprised and wonders how to keep track of such a large portfolio. Amit says that he does not monitor his portfolio, but goes strictly by the advice given by his investment advisor.

This story may apply equally well to many mutual fund investors.

There is a common notion that the greater the diversification, the higher the gains, and the better the returns. However, investors have to watch out for the perils of over-diversification. Diversification involves costs — more paperwork, higher transaction costs and costs of opportunities lost.

Mutual Fund: A risk diversifier

Fund investing is different from stock investing. A mutual fund is a risk diversifier in itself. It invests in a basket of equities, enabling one to earn the benefits of investing in a diversified portfolio with even a small outlay. If you go for diversification even with mutual fund holdings, it is a distinct possibility that the very purpose of investment may be defeated.

This is because it can nullify the very purpose of fund investing, which is to outperform the benchmark. At any point of time, a few funds in your portfolio may be laggards or underperformers. This may pull down the overall performance of your MF investment.

The NFO trail

Fund houses, in a race for increasing the assets under management, have taken to rolling out a steady stream of new fund offers (NFOs). The advice received from your next door financial advisor is that your needs are best met by subscribing to NFOs of specialised mutual fund with fanciful names.

There are funds operating in different market cap segments — large, medium, small and micro-cap funds.

There is a fund for investing in companies that will benefit from increased infrastructure spending and one for only companies that will benefit from increased consumer spending. There are even funds that specialise in companies of all sizes, which are no different from plain diversified funds.

Investor’s dilemma

At the end of the day, you have an investor who ends up steadily adding to his fund portfolio so that he does not miss out on any of these ‘opportunities’.

This is due to lack of understanding of the mutual fund concept (some people approach them much like stocks). The concept of a mutual fund makes sense only when the individual investor does not have to figure out which companies to invest in or which fund to invest in.

If the predicament of choosing stocks is to be replaced by that of figuring out whether a given bit of money should go into this theme fund or that one, then nothing much has been achieved. This kind of investing doesn’t help anyone, except the mutual fund distributors.

What should the investor do?

A basket of more than 15 to 20 funds, each based on a different theme, is impossible to monitor and organise. Instead of investing a few thousand rupees in every new fund offer, a Systematic Investment Plan in funds with a good record may help you create a substantial asset base for yourself over a period of time. Investors not too savvy with themes or sectors should best stick to ‘diversified equity funds’ only.

Do remember equity investments give healthy returns in the long run. No other asset class can match them in terms of liquidity, returns, and convenience of investing. Hence have a systematic approach to investing in a basket of time-tested funds, this is the best way to build a solid portfolio.

(The author is an AICWA, ACS and a freelance writer on personal finance.)

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