Don't spread your investments too thin, experts tell Joydeep Ghosh and Sanjay Kumar Singh.
In the past, when the stock markets were on a roll, many mutual fund houses would launch new fund offers (NFOs) in the equities segment to gather fresh funds.
The usual pitch from distributors: NFOs, in which units are priced at Rs 10 per unit, are cheaper than existing schemes whose net asset values (NAVs) have gone up.
The pitch was misleading, yet many investors fell for it.
A leading mutual fund distributor remembers getting a client who had a portfolio of Rs 10 lakh. The number of schemes: 120. "This investor had bought almost every NFO. He had almost every large-cap fund with more or less similar stocks."
Thankfully, in the past decade, things have changed quite dramatically.
With successive chairpersons of the market regulator, the Securities and Exchange Board of India, insisting on consolidation of schemes at the fund house level, the number of schemes with similar themes and stocks has come down significantly.
The number of NFOs in the equity segment is also down significantly.
While mutual fund houses have shown restraint in recent times, financial planners and industry experts say that there are many investors who continue to make the mistake of having several similar schemes in their portfolios.
This is a futile strategy because it is unlikely to improve your returns significantly.
"We keep getting clients who have 50 to 60 schemes. Many of these investors also feel they have a 'solid' portfolio. And it is not that the addition has been distributor driven, it is also investor driven," says Suresh Sadagopan, director, Ladder7 Financial Advisors.
"Many investors keep on putting pressure on their distributors to give them the latest top-performing scheme," Sadagopan adds.
1. Risks of having too many funds
The biggest risk is that while the overall portfolio might be doing quite well, there could be a number of laggards whose bad performance is getting hidden due to outperformance by others.
The bigger the size of your portfolio, the greater is the chance that you will have some mediocre funds in it that will drag down your portfolio returns.
Experts believe that investors may be over-buying funds because they see a specific strategy that has done well in the past and want to buy a fund from that category.
"When you have too many funds in your portfolio, it creates clutter. Managing so many funds becomes difficult. It is not a very systematic approach to investing," says Kaustubh Belapurkar, director-manager research, Morningstar Investment Adviser India.
"Your whole investing ideology gets lost. You're not able to track all the funds properly. There is no proper portfolio construction in such cases," Belapurkar adds.
2. Duplication of stocks limits returns
Let's look at the top stocks in India's top three large-cap funds, in terms of assets.
While the biggest fund in the large-cap category is SBI's exchange-traded fund (ETF) Nifty-50, it is not being considered because it mirrors the index.
The next three -- Birla SunLife Frontline Equity Fund, HDFC Top 200 and SBI Bluechip -- all with assets of over Rs 15,000 crore have four stocks in common in their top 10 picks.
These include HDFC Bank, State Bank of India, ICICI Bank and Infosys.
And the combined percentage holdings of these four stocks is over 15 per cent in all the three schemes' portfolios.
This is not a good signal for the investor.
"If you have too many funds in your portfolio, duplication becomes an issue. If a particular strategy is not working well in certain market conditions, and you have too many funds following the same strategy within your portfolio, all of them will underperform at the same time," says Vidya Bala, head of research, Fundsindia.com.
According to Bala, most investors have this urge to add top-performing funds to their portfolios. They may invest in a top performing fund.
Six months later, they may come across another fund which is doing even better.
Then, they have this urge to buy the second fund, hoping that it will improve portfolio performance.
"It is symptomatic of a very product-driven approach rather than a portfolio-construction approach. If they followed an asset allocation approach, they would limit the number of funds in their portfolios," adds Belapurkar.
3. Pruning can be painful, but do it
It is not easy to bring down the number of funds in your portfolio.
In case of equity, there could be exit loads or tax implications in case the investor has been putting money through systematic investment plans (SIPs), or a short-term capital gains tax, if the fund has been bought less than a year back.
"In such cases, we have to wait till a number of SIPs have completed the one-year timeline so that there is no tax incidence," adds Sadagopan.
In case of debt, exiting immediately can be much more complicated because of the tax implication of exiting before three years (capital gains are added to income and taxed according to the income tax bracket).
In such cases, reducing the number of schemes can take a significant amount of time.
"Sometimes, if the tax incidence is not very high, we ask the investor to bite the bullet and pay the tax," says Sadagopan.
4. While constructing a portfolio...
Keep it simple.
"Decide your asset allocation and category allocation. Then put a couple of funds in each category. You will realise that following this approach of asset allocation and category allocation will itself give you diversification," says Bala.
Suppose that you are investing in your debt portfolio.
You decide that you have a timeframe of three years.
You could possibly have one fund to play the duration strategy and one fund to play the income accrual strategy.
This would be better than holding two or three dynamic bond funds.
Sadagopan says that even if you have a Rs 1 crore worth portfolio divided between debt and equity, don't have more than 10 to 12 funds.
This would include funds for liquidity during contingencies, and funds for medium and long-term goals.