Be wary of cross-holding of firms in your mutual fund portfolio

Choose funds that invest in different segments & follow different investment strategies

Merely choosing mutual fund (MF) schemes from different fund houses or opting for a large number of funds is not enough to have a diversified portfolio. This is the mistake most of us make while investing in MFs. What we forget is that an MF is a diversified form of equity investment and, therefore, while choosing MFs we need to be aware of the kind of companies they invest in.

Many investors have 50-100 schemes in their portfolios. But a portfolio of 10 schemes can give better returns than a portfolio of 50, if selected effectively. Ideally, an investor should not have more than eight schemes, say experts.

Hemant Rustagi of Wiseinvestadvisors says MF portfolios of most investors tend to have similar funds investing in similar companies, and, therefore, behave in a similar manner. So, the trick is not to have too many funds in the same category, but to choose funds that invest in different segments and follow different investment strategies.

TAKING A DECISION
If the companies in your funds overlap, keep these points in mind before deciding which one to keep or sell

1. Look at your entire portfolio to check how much exposure you have to any particular fund category, such as large-cap, mid-cap or small-cap
    
2. Take a micro view of the list of companies held by the funds, to see if there is excessive exposure to any one stock or company.
    
3. Returns from the fund are important but these should not be the only consideration
    
4. Take the final decision based on your risk appetite. Check if the investment philosophy of the fund is beyond your risk taking capacity
    
5. Ideally, you should not re-balance your portfolio more than two or three times a year
    
6. Check if the fund is not following its stated investment philosophy

For instance, if you have invested in an index fund and in a large-cap fund, there could be many companies that are common in the portfolios of both funds.

Most equity diversified schemes hold the same stocks and sectors. For example, the top five holdings of HDFC Top 200 and Reliance Top 200 have three stocks in common, which are State Bank of India, Infosys and ICICI Bank.

Similarly, in the mid-cap segment, you have options such as a normal mid-cap fund, an opportunity fund and a value fund. An opportunity fund will try to invest in those companies which can perform better than the market, going ahead. While a value fund will look at the value of the company today as against its intrinsic value. Here, too, there could be some overlap between the opportunity fund and the value fund. For instance, ICICI Prudential Discovery Fund, which is a mid- and small-cap value fund and HDFC Opportunities, which is a mid-cap fund have common stocks such as Divi's Laboratories, Torrent Pharmaceuticals, MindTree and Amara Raja Batteries.

"The reason we invest in different mutual funds is to attain proper diversification. When we invest in two mutual funds that have exposure to the same stock, we reduce the impact of diversification. Ideally, investors should look at the holdings of the funds they are investing in, before buying them,'' says Nitin Vyakaranam, chief executive officer, ArthaYantra, an integrated personal finance services company.

The investment strategy or philosophy stated in the fund's fact sheet gives an indication of the risk and likely returns. The fund cannot deviate from this strategy without the consent of investors. So, choose the kind of fund you want based on your risk appetite.