Do you hold more than 10 schemes? Beware!

Multi Colored Problem curl explosion. Psychedelic cyclone organized with scattered problem objects. Vector illustration style is flat iconic symbols.
Multi Colored Problem curl explosion. Psychedelic cyclone organized with scattered problem objects. Vector illustration style is flat iconic symbols.

By Vijayananda Prabhu

In the May edition (Who moved my scheme?) of Geojit Insights, we braced upon the information which every investor should have at the top of their short term memory and apply them as and when mutual fund portfolio restructuring decisions are called for. Majority of the investors would have invested in a scheme based on the recommendation from an advisor, with or without understanding the scheme objective and suitability of the scheme to their risk profile. It’s also possible that investors view their mutual fund portfolio as individual schemes rather than a single big portfolio. They may not have overall picture of cap wise, as well as sector wise allocation, and keep on investing in new schemes without understanding the objective and required results. Many of the investors have more than ten folios/schemes, most of the time skewed towards a particular market capitalisation. Does it really help? What needs to be done? Why now? Let’s find out.

Another scheme? Say NO.

The new scheme categorisation circular has set clear classification between large, mid and small-cap companies (first 100 companies by market cap are large-cap, then up to 250 are mid-cap and beyond that are small-cap companies). Though there is a large investment universe of more than 4000 stocks in the market, the investment universe chosen by most of the mutual fund companies are confined to the first 500 companies. So if an investor take five large cap funds, he/she could see same stocks appearing in multiple portfolios. How does it harm the returns?

What happens when one invests in multiple schemes? A fund manager intends to generate alpha (beat the benchmark) by taking calculated decisions on the sector or stock allocation in his scheme. When an investor chooses to invest in two schemes of the same category, this allocation idea gets disrupted from an overall portfolio perspective. It’s true that one tries to mitigate fund manager risk, but somewhere it affects the returns. As an investor adds more schemes to the portfolio, their returns come down and get closer to the benchmark (which you will never wish to). It can even happen that, once diversification crosses a certain limit, the overall portfolio starts underperforming the benchmark. Now, why should one pay an expense ratio of more than 2% in an equity mutual fund portfolio which only yields benchmark returns? At this point the investor should also understand that, through investing in five schemes, they are holding a 250 stock portfolio. Even if one argues that there will be an overlap of stocks between the schemes, and will have at least 125 stocks in their overall MF portfolio which by itself is too huge. If the investor take another perspective, risk is the determinant of return. As diversification increases, risk decreases and so does the returns.

There is collective intelligence on one side and there is smart work on another side. In emerging countries, where markets are in a nascent stage, prices do not always reflect all available information. Hence, it is less challenging to generate alpha. We have seen this in the past where a majority of Indian fund managers were smart enough in beating benchmark returns across time periods. But when markets grow bigger and mature, alpha generating opportunities diminish. In developed countries like US, where markets are much mature and bigger than emerging markets, the scene is different. As the efficient market hypothesis states, markets there are strong form efficient (which means, any information cannot fetch you higher returns than the market, as market readily reflects all information) and majority of fund managers struggle to beat ETF returns. We have witnessed this scenario in US in the recent past.

Most of us invest to generate high returns over long term. We always wish to hear our portfolio generate better returns than peers. In a fast developing market if we do not take prudent portfolio decisions, our aim of generating alpha and meeting return objectives will never be fulfilled.

What should be done?

Always try to see the overall investments as a single portfolio starting from asset class, to investment vehicles, then to categories and classifications within those vehicles. For example, make a document of all your financial and physical assets and see what the allocation into each asset class is. Within each asset class, have a closer look at each investment vehicle, for e.g., if equity is an asset class, look at direct equity, mutual funds etc. and check for the overall stock and sector allocation. This exercise will throw light over any skewed allocation and will help you to take corrective actions to bring the portfolio to desired shape.

In the mutual fund front, look out for your overall sector and market cap wise allocation of your portfolio. Then, check if you are holding more than one scheme in a particular category (say large-cap). You should have a target market cap allocation to suit your risk profile and your scheme allocation should be in line with this target allocation. If you have more than one scheme in a category, try to get out of the one which is underperforming. Now the question is, what is the ideal number of schemes one can hold? I would say, including debt and equity one need not hold more than six schemes. Gold and ELSS schemes are beyond this number. (If you could associate an ELSS scheme with any of the life goal, then you can include that too in your six scheme list)

If you are a long term investor, then in your equity portfolio, you can have three multi cap funds managed by the top three fund managers. Different from holding three large cap funds, holding three multi cap funds can help you to benefit from the market cap allocation ideas that these fund managers carry. This can reduce risk through collective intelligence and increase possibility of higher returns through smart picks. Debt portfolio always depends upon your investment horizon. If you are risk averse, go short and if you can take risk, go for longer duration or rather dynamic bond funds.

Why Now?

Now that the scheme categorisation programme is on its wheels, each investor will have one or other scheme in his portfolio changing its basic attribute. So every investor is now forced to review his/her portfolio and take corrective action and bring their portfolio to desired allocation. Let’s use this opportunity to rejuvenate your mutual fund portfolio. Make it a slim and trim looking list of schemes with least overlapping stock positions. If you wish to invest more money, set SIPs or make additional purchases in existing schemes than investing in new schemes. Exit a scheme only if there is continued underperformance, or there is a fundamental change in its attribute, or if the fund manager or management changes.

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