The Hindu Business Line : Fund Talk

You have been recommending strongly that a portfolio should contain a maximum of five or six funds with a good track record, with one or two large-cap funds, one mid-cap, and so on. Had I invested in funds over the last year or two and included only one mid- cap fund — say, Franklin India Prima, which has a terrific track record — I would have lost heavily. It failed to deliver in the last year compared to peers such as Sundaram Select Midcap, Magnum Global and Birla Midcap. There are similar cases among large-cap funds too.

Is it not wise to choose two or three funds in each category from different fund houses and form a portfolio rather than investing in only one fund / fund manager? Although the potential returns may be diluted, the average return from investing in several funds with a good track record should be better than holding one fund that didn't perform the whole year. Tracking also is not much of a problem with some of the efficient portfolio managers available on the Web, especially if you choose the growth option.

Sreenivas

Dubai

You have rightly pointed out the need to diversify your portfolio. It is impossible to choose a single fund that will always outperform, so you do need to spread your investments across a couple of funds. A single fund may deliver a strong performance in some periods and may take a plunge at other times. Diversifying across funds will help even out the returns in your equity portfolio. However, how many funds do you need to include in your portfolio for you to realise the benefits of diversification?

Typically, if your investments in equity make up a small portion of your overall assets — say, less than 20 per cent — you may not need to diversify much further within your equity portfolio. In such a case, three or four funds should be more than sufficient to give your overall portfolio the equity pep. For an investor who has a large investible surplus and a substantial allocation to equity, there is scope for adding funds of various styles and risk profiles in the interest of diversification. Here too, however, a portfolio of more than ten funds is rarely necessary.

The depth of mutual fund offerings has improved in recent years, with new fund launches trying hard to capitalise on every new investment idea. Yet, few funds succeed in maintaining a truly distinct portfolio. You may find that your diversified fund invests in the same sectors as your theme fund. Thus, while you may own several funds, you are not really achieving the level of diversification you think you are.

Secondly, while portfolio managers on the Web make it easy for you to keep track of each fund's returns, it may not help you in making appropriate choices when re-balancing your portfolio or renewing your investments across funds. This is because past returns cannot be the only factor that prompts your buying or selling decision. A closer look at portfolios, for instance, might reveal that a fund's outperformance or lag in performance, as the case may be, was just a temporary blip or aberration.

A strong sector bias or a contrarian approach that might have influenced short-term returns may have a different bearing on performance over the long term. This kind of periodic analysis will certainly not be easy if you have more than a dozen funds in your portfolio. You might end up investing more money in a fund whose superior performance may not be sustainable, or punishing a fund with good long-term potential.

You can both diversify your portfolio and keep it compact if you follow a few thumb rules. One, stick to diversified funds with a track record and avoid new fund offers. This automatically narrows your choice set to a manageable number.

Two, avoid picking funds that focus on the same theme, say, lifestyle or infrastructure, even though they belong to different fund-houses. Even within a category, it is possible to diversify by choosing funds with different management styles. For instance, while Franklin Bluechip is a strictly large-cap fund that rarely picks stocks outside the Sensex, HDFC Top 200 tends to pick a couple of stocks in the mid-cap category.

Three, maintain a core portfolio that reflects your risk appetite. For instance, if you are an aggressive investor, you can choose about four or five funds that have a sizeable allocation to mid-caps or concentrated investment strategy, which could make up about 60 per cent of your fund portfolio. Such an allocation could help meet your return objectives while at the same time offer the diversification that would reduce downside risk.

Queries may be e-mailed to mf@thehindu.co.in, or sent by post to Business Line, 859- 860, Anna Salai, Chennai 600002.

Shanthi Venkataraman

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