Have you lost the count of mutual fund schemes in your portfolio? A compensation system that was in place for the agents selling funds earlier ensured that you were sold every new fund offer that hit the market. It is not uncommon to find investors holding 25-30 schemes with most of them doing the same job.
So, why is that a problem? Basically, a mutual fund is a pool of money that is handed over to a manager who invests the money according to a common mandate. So, there will be funds that will only invest in large-cap companies with the aim of giving broad market index-linked returns. Then there will be funds that take more risk and focus on the mid- and small-cap segment. Few others will have a view on infrastructure stocks and others on consumer goods. In a portfolio, schemes should be chosen to provide diversification to reduce the risk, per unit of return.
But, having too many schemes, which promise to go to the same destination, will do nothing for diversification. The Nobel Prize winning economist, Harry Markowitz, the father of the Modern Portfolio Theory in 1952, said that diversification beyond a point does not reduce risk. Professors John Evans and Stephen Archer from the University of Washington, in a paper published in 1968, said that 10 randomly selected stocks are enough to achieve diversification.
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So, what should you do if you find yourself sitting on too many funds? Here’s Money Matters’s guide to your mutual funds portfolio trimming.
Check fund performance
The first step is to check the performance of the funds you hold and accept that you made a bad investment, if any. But before taking a decision, check out the reasons behind its underperformance.
For instance, in 2008, mid-cap funds lost 60% as against a loss of 59% by CNX Mid-cap. During that period, illiquid markets and global uncertainties pulled down not just select funds, but almost every fund that invested in the market. At such times, the decision could not be based merely on the performance of a particular fund. At the same time, however, JM Small and Mid Cap Fund was at the bottom of the pit on account of some risky moves and bad calls that it had taken in the past.
Don’t stick to one MF
It’s natural to get swayed by a fund house that does well across schemes and buy more than one scheme from it. Though your MF investments are actually in a trust under the Indian Trusts Act, 1882 and your money is safe even if the fund house gets into trouble, it’s always better to spread your risks to maintain a balance in your returns in case something goes wrong.
Four of DSP BlackRock MF’s schemes have outperformed their respective category averages and two of these are top-quartile performers, out of a total of five of its equity-oriented funds accounted by mutual funds tracker Morningstar India in its November fund ratings. But that doesn’t mean you should buy all schemes in DSP BlackRock.
Make a list of such schemes within your chosen fund house. Check out whether any of the schemes have outlived their utility. For instance, you may want to retain a well-performing large-cap fund. However, if the mid-cap fund from the same family has become a fat fund over time, switching to a more nimble mid-cap would be a better idea even if the mid-cap you hold has shown good performance.
Don’t stick to one sector
Not so long ago, infrastructure funds had caught the fancy of fund houses, agents and investors alike. For instance, Tata MF has four types of infrastructure funds. Between them, they invest in Indian, emerging and global companies in infrastructure sectors. All the four funds have different characteristics, but the same investment avenues, which limits diversification. Says Bangalore-based financial planner Lovaii Navlakhi: “Usually, infrastructure funds are a small portion of a portfolio. One, or at the most two, funds are enough.”
Watch out for tax burden
Before taking the final call, you need to run one last check—make sure you are not taxed for getting out of a fund. If you sell an equity fund before completing a year, you will have to pay 15.45% short-term capital gains tax (including cess). This tax is not applicable after the fund has completed one year with you.
Says Mumbai-based financial planner Gaurav Mashruwala: “Unless you desperately need money, it’s best to hold a fund for a year. Of course, if it’s a disaster scheme, it pays to exit immediately.”
Once you have identified the duds, you need to get rid of them. For a normal fund, you just need to withdraw the money and the fund gets automatically closed.
In case of a systematic investment plan linked directly to your bank account, send a letter to the fund house to stop the deductions. Redeem, only after you get an acknowledgment from the fund house.