I am in my 20s. I have around 50 mutual fund schemes. What is the right amount to have? I thought of reducing it to 20 schemes. Is that sufficient?
This is an extremely intriguing situation. For one, the reader who wrote in is very young, but still has an exceptionally bloated portfolio. While we don’t know what led to this and are unaware of the funds and their respective allocations, we would like to broach the subject of diversification.
Diversification is an important aspect to look at while building your portfolio, as it cushions the portfolio against any adverse movements, since different asset classes, (equities, fixed-income, gold, commodities) respond differently to the same set of economic drivers.
For example, having exposure to gold and fixed-income in your portfolio during the recent market slump in February-March 2020 would have mitigated the drawdown relative to an equity-only portfolio.
Diversification looks to achieve an optimal risk-to-reward ratio. It works only when the assets in a portfolio respond differently to the same set of fundamental/economic drivers. For example, adding consumer defensive stocks to a portfolio of auto stocks would serve as a cushion during downturns, as these are likely to fall less due to the lower demand elasticity of the consumer products. Even securities within an asset class can respond differently to the same set of drivers given their company specific factors. For example, different auto stocks are unlikely to witness similar falls during times of economic downturn, depending on their product mix (for eg. 2 or 4-wheeler) and the impact of the downturn on the target audience (rural/urban/exports). More recently, we witnessed pharma and infotech stocks rising while financial services’ stocks took a nasty beating amid the COVID-19 led sell-off in the markets in February-March.
Keep it simple.
Having numerous funds and stocks in a portfolio is not smart diversification. The aim of diversification is to lower overall portfolio volatility and mitigate the risk of extreme drawdowns. You don’t need to go overboard to achieve that.
The number cited – 50, is clearly excessive. Not only would there be a significant overlap (in terms of stocks and types of funds), but it will be extremely cumbersome to track.
The number of funds in a portfolio should be a function of the recommended asset-allocation mix for an investor, and the funds chosen to meet that mix. A typical multi-asset portfolio may have exposure to a maximum of 15 schemes.
Clear the clutter.
On an excel sheet, list down all the funds with the relevant category. At a glance, you will see the number of funds you have in a single category, and where the considerable overlap is. The portfolio’s concentration at the AMC/fund-manager (within equities/fixed-income) level and to a particular style (value/growth) should also be evaluated and capped accordingly. Having concentrated exposures subjects an investor to the risk of a single scheme’s performance. On the other hand, having very low exposure to a fund does not have any material impact on the overall portfolio, rendering the exposure meaningless.
An appropriate asset allocation would depend on your risk appetite, which accounts for your ability and willingness to withstand volatility. It is advisable to get your risk appetite assessed before deciding upon the asset allocation. Being 20, one would assume that the bulk of your portfolio is in equities. So if you have just 30% of your portfolio in equity and the rest in debt, then you know where most of the offloading should happen.
The foundation of an equity portfolio must be a large-cap fund; ensure that you have this. But also check if you have way too much exposure to sector or thematic funds. Generally, we caution against these as their performance is cyclical and relatively more volatile than other equity funds. Also, check the diversification within market caps. For example, is the bulk of your equity exposure to small caps?
Do you have funds that give you global exposure? This should be retained as they offer an opportunity to participate in growth opportunities in international markets and a hedge against currency risk. Or to gold? The allocation to gold can be about 5-10% of the portfolio.
If there is a high degree of similarity between a pair of funds, stick to the lower-cost option. You can also consider adding passive funds to your allocation, which would further aid a reduction in overall cost.
Also, keep in mind exit loads (if you exit within a particular time frame) and taxation issues (capital gains). Please consult your financial advisor before making any investment decisions.
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