There is no denying that holding a reasonable number of stocks can provide diversification to a mutual fund’s portfolio. But some equity schemes have walked the extra mile.

WOC Flexi Cap, ICICI Prudential Multicap, Bandhan Emerging Businesses, HDFC Large & Midcap and Nippon Small Cap funds, for example, have among the highest individual stock holdings, going up to 200 in their respective portfolios, per September 2023 data.

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Fund sizes becoming large necessitating wider holdings, regulatory requirement on investing specific proportions in specific market-cap segments (large, mid and small) in certain category of funds, low liquidity in certain counters, and means to reduce portfolio risk are some common reasons cited by fund houses for such large holdings. However, a long tail may also be a negative.

Risk management

In the small-cap stocks space, there is the challenge of relatively low liquidity. And as asset size swells (Nippon Life Small Cap has an AUM of ₹37,374 crore, for instance) even a small stake (0.5-1 per cent) is large in absolute terms in the context of small-caps. Liquidity constraints and downside protection combined necessitate buying of more stocks.

Says Samir Rachh, Fund Manager, Equity Investments, Nippon India Mutual Fund, “We feel diversification is necessary as a part of risk management in small-caps considering the overall low liquidity in the space.”

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Manish Gunwani, Head, Equities, Bandhan AMC, has a different take. He says, “The universe of small-caps has gone up significantly over the last few years and we expect this trend to continue. Hence, we expect to continue having a high number of stocks in the fund.” Gunwani adds that having large stock holdings protects against macro risks (interest rate, currency) and price volatility in the small-cap space.

In the multi-cap space, a fund manager, requesting anonymity, said that their fund size is large and that a 25:25:25 mandate (in large, mid and small cap stocks)  means that they must spread their holdings thin, especially on small-caps.

A downside?

While holding 100-plus stocks may become unwieldy and probably result in a long tail of tiny stock positions, Whiteoak Capital Mutual Fund’s Ramesh Mantri has an interesting take.

“The number of stocks in a portfolio is a function of the research team size. We have a 32-member research team that tracks more stocks and sectors extensively, many of which are not covered by brokers. A 0.5-1 per cent stake in a well-researched small-cap with potential can add far more value than a well-discovered large-cap. In many of the small-caps that went for public, we are among the earliest institutional investors,” he says.

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But where will the alpha (excess return) come from if the tail is long? Says Samir Rachh, “The only way we can generate alpha despite diversification is that we will have to continuously add winners in our top 25/50 positions.” Another fund manager also agrees on this.

While most of the fund managers have a clear thought process behind their large stock holdings, ultimately, fund performance matters most for investors. So long as large holdings don’t become a drag on returns, there isn’t any major reason for concern, yet.

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