You own 227 stocks or more. It’s time to re-look at your portfolio

I am primarily a stock investor. Direct stocks. Although I've occasionally ventured into mutual funds, it has always been two steps forward, and one step back. But as on date, mutual funds have snagged a substantial part of my investment pie - 99% in a single scheme, no less. It's a bold move, abandoning diversification, but hold that thought.

Today, I sought advice from an experienced investment advisor, a friend, on long-term investing for someone middle-aged and with an appetite for risk. His suggestions spanned five funds, from largecaps to smallcaps. 

Here are the recommendations:

Fund A – Largecap fund

Fund B – Largecap fund

Fund C – Flexicap fund

Fund D – Midcap fund

Fund E – Smallcap fund

While I won't bore you with the specifics, the aggregate data from these funds' portfolios was startling: 227 unique stocks across 45 sectors.

Wow. These numbers surprised me.

Then he mentioned something intriguing: the extremes of diversification he's seen range from 10 to a whopping 60 mutual funds in one portfolio. Imagine that—owning a slice of almost every "investible" stock in the market. Investible here meaning stocks that make the cut for institutional investment.

For context, given a total of 2,137 companies are listed on the NSE (as of March 2023), if you have 10 funds, you're likely holding shares in around 20% of all companies listed on the bourse, about 400 stocks. 

Those with 60 funds? Well, your guess is as good as mine.

Let's circle back to my choice of minimal diversification. It's a conviction thing. You see, I have always believed that if you have a high conviction investment opportunity then your investment needs to reflect that. Given such opportunities are rare, it’s common for investors to have concentrated portfolios. 

Think Warren Buffett and Apple; when you stumble upon a golden investment, you go all in—Buffett did, to the tune of 50% of Berkshire’s portfolio. That’s what you do when you have a high conviction investment opportunity available to you.

You see, in the case of stocks, the idea of a concentrated portfolio is an easy one to make. We have examples all around us. Successful investors who earned their fortune from a handful of investment decisions.

Translating this to mutual funds is trickier.

I have no clear answer to this. And that’s because my experience with a concentrated approach to investing in mutual funds is not long enough (I have almost all my mutual fund money in one scheme only, having a total of 30 stocks in it). My approach – find the right fund management team, and then bet on them to deliver over the long term. Over time we will know if this works.

Having said that, let’s go through some pointers that could perhaps help clear the air a bit.

First, I think while opinion may be split about diversification and performance, there’s a golden mean somewhere. The right balance between performance and diversification. My gut tells me that having just one equity fund is too concentrated, and 10, perhaps, too diversified. If you had to own that many equity funds, you would perhaps be far better off with an extremely low-cost index fund. You anyway own almost all the stocks that are investible (via the funds), so might as well save on the cost of fund management!

(Perhaps someone has done the numbers on this already. If you have, do share, and I will try and put it out, with credits, via this column).

Second, it appears to me that some think about their mutual fund portfolios like a stock portfolio, where they are happy to move in and out. So, when an opportunity presents itself, you move in (Selling out is always tough, and that’s one reason why accumulation happens.). For instance, today it is all about thematic funds – India rising, capex, smallcap et cetera. And many, perhaps including you, are rushing in.

Mutual funds are bound to come up with schemes that are likely to sell. This is why you have not seen anyone launch a large cap focussed scheme in this market! (If someone has launched, they know their stuff. Invest with them!).

The whole idea instead should be to find the right fund management team and bet on them to do a good job for you. Leave it to them to pick opportunities for you across the length and breadth of the market (called “Flexicap" now). If the new thematic opportunities you are excited about are genuine there is a fair chance your fund management team is already there. And if not, take a pause and ask yourself why not? Maybe even ask them when they visit your neighbourhood/town. Usually there’s a reason. My flexicap scheme for instance, has no direct exposure to any of the high-flying themes of the day. And I am doing just fine!

Review performance, say annually, and if broadly things are right, you stick on. If not, you put the scheme on watch, and over time if things don’t change, you switch.

The key here is to select the right team and then leave it to them to do the stock picking, holding, and exiting. Of course, if you find that suddenly your long term focused fund management team is suddenly excited about 100 p/e stocks, be sure to find out what’s up. It’s your money at stake after all! You want to make a lot of wealth over the long term. But you don’t want to do it at any cost. Because that could put your wealth at unnecessary risk.

Third, and my final point, is that the portfolio of funds you own should be a direct result of your financial planning, and the optimised asset allocation to help you reach your goals. If you approach investing from this perspective, you will not need to keep adding equity schemes to your portfolio. People who stick to this approach, generally tend to have not many stocks or equity funds in their portfolio. It just works. Always start with your financial plan and allocation. Try it.

In an earlier edition of Contramoney, I wrote about when it is the right time to fire your investment advisor. Perhaps, you could also read it as how to select, or trust, one. It may be a good time to revisit this.

Happy investing.

Rahul Goel is the former CEO of Equitymaster. You can tweet him @rahulgoel477.

You should always consult your personal investment advisor/wealth manager before making any decisions.