The 32 fund portfolio – Diversification vs Diworsification

How many funds do you have in your portfolio?

“I will have to count.”

After 10 minutes.

“It is 32 funds.”

Did you say 32?

“Yes.”

What are these many schemes doing in your portfolio?

“Diversification.” It was mentioned as a matter-of-fact. 

What does having 32 Mutual Funds in your portfolio mean?

Let’s understand this in two parts.

Part 1: It means a lot.

You believed in the theory that about 25 to 30 stocks make a good diversified portfolio and hence that would be true for mutual funds as well.

You believed that diversification is the best bet against ignorance or so said the Oracle of Omaha  – you don’t exactly know the right fund to invest in and hence accumulate many – at least some will perform.

You used the holy grail of past performance as the only metric to select your ‘best‘ funds. So, every year there were new 5 funds topping the charts, which you included in the portfolio. But you were never sure what to do with the ones you already had bought. So, they also stayed.

There were the experts in media, your friends, colleagues, family who were investing. They would confidently mention ‘their‘ funds. The more the people, more the vices, sorry voices. Hence, more the funds. These are people you trust, they cannot be wrong.

Finally, you believed that since the amount to be invested is large, it should be spread across many more funds. Your advisors and your bank relationship managers supported the thought. Actually, they were only interested in the latest sale.

So, here you are with 32 funds.

Part 2: Actually, it means nothing.

You took a short cut. Instead of knowing better, you just added more funds. More and more was only a cover for stupidity. Diversification can protect against ignorance but not stupidity.

You have flexi-caps, mid-caps, large caps, small caps, sectoral funds, debt-liquid, short-term, ultra short-term, FMP and of course, a Gold fund. Is anything left?

See the image below.

NO. OF FUNDS BY CATEGORY & THEIR WEIGHTAGE IN THE PORTFOLIO 

Each of your 32 funds has an average weight of  about 3% in the portfolio. Even if one of them doubles in value, it would not have more than 3% impact on your portfolio.

Frankly, in an effort to achieve diversification, you have achieved diworsification.

You have only created more work for yourself – to track and manage all the 32 funds. It is an investing nightmare.

What should be done now?

One simple answer – Surgery. Yes. Here’s how.

#1 There is no role for 32 funds in a portfolio. Even from a diversification point of view, you should not have more than 7 funds. So, now you have to remove 25 funds, that is, 78% of your overall total of 32.

Simple. There are several funds which have the same mandates, are in same categories – do away with these multiple schemes. They don’t add any value.

Each of your chosen funds should give you diversification in true sense. They should bring something unique to the portfolio.

Just focus on having 1 fund per category if at all. And you got to know your funds well. There is absolutely no place for sectoral or thematic funds unless you are sure of what you are doing.

Take, for example, these 5 mutual funds:

You can click on the names of each to see detailed info on each fund.

1. Franklin India Blue chip Fund – A true blue large cap fund which invests in the largest companies of the Indian Stock Markets. With an existence of over 23 years, it is a veteran fund.

2. Quantum Long Term Equity Fund – This fund invests in the large/mid cap stocks predominantly in the Top 200 stocks of the Bombay Stock Exchange. It doesn’t mind holding cash if no investment opportunities are available to the fund.

3. Sundaram Select Mid-cap – This is a true blue mid cap fund. It has so far adhered to its mandate of being invested in mid cap stocks only. By its own restriction, it doesn’t invest in top 50 companies by market capitalisation on the National Stock Exchange.

4. PPFAS Long Term Value Fund – This is a flexi-cap fund. It doesn’t believe in any boundaries and can pick stocks from outside India as well. In fact, it has about 30% of its current portfolio invested in stocks from countries other than India.

5. DSP Blackrock Micro cap fund – This is a pure micro cap fund; doesn’t invest in top 300 companies by market capitalisation as defined in its own mandate. This leaves only the small and micro companies in its universe of investment opportunities. Its job is to pick the hidden gems from there. Warning: this fund should be considered by an super aggressive investor only who is willing to live with extreme volatility.

All the above offer a unique value proposition, an investment style and belong to a different category.

“What about debt mutual funds?”

Yes, if  your asset allocation provides for debt allocation, you should have a debt investment too such as in debt funds. However, count your other debt investments such as EPF/PPF, Bank FDs, etc as your debt and don’t exceed your overall allocation.

For debt funds, stick to ultra short-term / short-term category for your investments. Choose liquid funds if you may need the money soon.

#2 Take into account the capital gains and exit loads and then switch or redeem as the case may be. You can do this on Unovest itself.

#3 For the next one year, you should do a clean-up every quarter – because of the capital gains and exit loads, investments will become free to switch or redeem. Post that, do an annual review cum clean-up exercise – where you revisit your portfolio, the funds and take action on what should stay and what should not?

Keep your portfolio lean. The purpose of a portfolio is to help you achieve your goals. Focus on that.

“Wouldn’t that make the portfolio concentrated in a few funds and hence increase risk?”

I understand what you are asking. No, it wouldn’t. Mutual funds by themselves are diversified. They have investments in 20, 30, 50 or 100 stocks. If you have 5 funds, you could be holding, about 150 to 200 stocks overall.

It is ok if a few funds get a large allocation. Investments with larger allocation will make a significant difference to your portfolio with their growth. A fund that has 20% allocation to your portfolio will make a 20% difference.

In any case, you have to do your homework in choosing your funds. Don’t just rely on the past performance. There is lot more to a fund. If you can’t manage it, hire a fee-only advisor.

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Disclaimer: The specific mutual fund schemes mentioned in this post are only examples. Please do not consider them as investment advice. Thank you.