Go for diversification in MFs to avoid risks

There has been a slew of SOS calls in the past few weeks from investors. I’ve witnessed many of these investors taking an extreme range of investing in the mutual funds with their portfolios skewed towards mid and small cap funds. Further questioning led me to understand that they’ve considered the past performance of these funds while investing which most of these have done about two years back. That was a period when many of these funds have outperformed the broader markets way ahead for the 3 and 5-year horizon.

Despite a clear disclaimer by the mutual fund houses and AMFI (Association of mutual funds in India) that “past performance is not a guarantee for the future returns”, investors still tend to keep this as a major barometer to invest. Even this lone parameter couldn’t have caused a havoc in their portfolios if the investors have diversified into other categories of MF. It shouldn’t ideally have caused any worry for the investor just because of the underperformance but it’s the mismatch in the expectation and the timelines they were looking at making returns of these investments.

The other common denominator I’ve witnessed in all these distressed investors is not averaging the investments. Most of these investors have gone lumpsum in these funds and didn’t top-up with any systematic investments to take advantage of the fall in the NAV (net asset value). Moreover, they’ve not acted until it was too late, or the returns were almost negligible or turned negative. And as I’d mentioned earlier, these investments are out of sync with their goals and timelines which added further pain.

Of course, the main peril I would sight is the lack of diversification in their portfolio. By investing all their investible surplus in hot (select) categories of funds, these investors had to take the brunt of the value erosion when these categories have failed. Ideally, to balance out the higher allocation into the mid & small cap funds, these investors could’ve been better off with a balancing exposure to large-cap, multi-cap and hybrid funds.

One has to always remember that no-one fund strategy suits all market environments and it’s wise to have diversified according to their risk appetite and timelines. Anyways, it’s always ideal to create a portfolio which has presence across the market breadth as a strategic allocation which reflects the risk tolerance, timelines and goals while using a time-bound approach through tactical allocation in any opportunistic areas or sectors or categories to gain from the prospects.

If one has clearly observed, the external (global factors) have helped some sectors like pharma, IT and other export-oriented companies to perform better about five years back and the cycle seems to have come back now. With the rupee depreciating, green shoots in global economic growth all aligning a growth in export driven businesses to make money, these sectors now again stand to gain.

Again, these cyclical changes have to be in-line with the tactical allocation whose percentage to the entire portfolio could be defined based on the risk appetite. This is like an additional fund that’s parked purely to take on any arbitrage created in the market due to the fluctuations, something similar to a corpus you would want to gamble in a casino. Of course, this is not a throw-away money but play with a calculated risk.

Overall, any investor should create a portfolio which could be non-correlated and spread across the market breadth so that some of the funds perform at most of the times while setting-off any negatives due to market aberrations. Simply put, a concentrated portfolio could deliver high returns but is prone to higher volatility and so should be avoided at most cases.

(K Naresh Kumar - The author is co-founder of “Wealocity”, a wealth management firm and could be reached at knk@wealocity.com)