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Look at the performance over a relevant period along with recent performance to identify consistent performers with risk profiles that suit the investor.
Look at the performance over a relevant period along with recent performance to identify consistent performers with risk profiles that suit the investor.

Make your mutual fund portfolio lean and sharp

  • Some funds may be consistently good performers but the their strategy and style may be too risky for the investor
  • Holding investments in under-performing funds means that your money is working less hard

If you cannot count the mutual fund schemes that you have invested in on your fingers, then you have one too many. A large number of mutual fund schemes does not really add to the diversification benefits of your portfolio and may in fact be a drag on its performance. Chasing the previous year’s best performer, believing an NFO to be a better deal, investing on recommendations without considering whether it fits in to your portfolio are all reasons why investors end up with an inflated portfolio. Do a fitness check for the schemes in your portfolio using these criteria to make sure they have a good reason to be part of it.

The Duplication Test

If you have multiple funds investing in the same segment of the market, say large cap, you may be adding more of the same stock since these funds have to invest in a defined set of stocks. So, while you may believe yourself to have done what it takes to be diversified, you may actually be taking concentrated exposure to a few stocks. Similarly, investing in sector funds may duplicate the exposure that a diversified equity fund you hold already has to the sector. A multi-cap fund with a large cap focus may again look very much like a large cap fund. A hybrid fund will have allocations across asset classes. “Look beyond how a fund is named or categorised and consider how the portfolio of each fund is exposed to different market capitalisation instead to see if there is any advantage of diversification in holding all these funds." says K Rajaraman of iAspire Services, a wealth advisory and mutual fund distribution company. “Once investors see the duplication in their portfolio we suggest consolidating their holdings to a few well-performing consistent funds", he added. Holding the same stocks or sectors across different schemes means you are increasing risks on one hand and on the other missing out on opportunities. Another risk is that when you hold a lot of funds in the same category you may end up holding the entire universe of stocks, say the 100 large cap stocks, and completely dilute the benefit of active fund management while paying the higher fees associated with it.

The Performance Test

Use the performance test to cut down the clutter in each category. Look at the performance over a relevant period along with recent performance to identify consistent performers with risk profiles that suit the investor. Consider the performance relative to the benchmark, peers and how long the fund has been under-performing to rank funds that need to go. Some funds may be consistently good performers but the fund’s strategy and style may be too risky for the investor. Find the right balance that is best suited for the investor’s goals, time horizon and risk tolerance. “We explain the impact of poor performing funds on the portfolio. Investors are then willing to exit and move to better performing funds and overcome their emotional attachment to certain selections,"said Rajaraman.

The Relevance Test

A fund must be relevant for the objectives that the investor is trying to meet. Funds that do not meet this criterion should face the axe. Funds that may have had a role earlier, say an ELSS fund used for tax savings in earning years but of no relevance in retirement, or, a token investment made in an international fund where the impact is negligible for the portfolio, are examples of investments that may not pass the relevance test. However, Rajaraman points out the need to accommodate investor preferences even if it does not completely align with the investor’s needs.

“Some investors like to hold funds focused on sectors they are employed in, like technology, and believe they are more comfortable with fortunes of the sector. You have to accommodate it to some extent", he said.

When you have an unwieldly portfolio, you loose track of the actual allocation to asset classes and sub-asset classes. And this means you may not be rebalancing correctly and managing risks and opportunities efficiently. Holding investments in under-performing funds means that your money is working less hard and moving them into funds that are actually aligned to your goals will give the portfolio the sharper edge it needs to get you to your goals.

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