Less is more: How to declutter mutual fund portfolios for better returns

A Motilal Oswal study noted that the June quarter of 2024 saw the launch of 35 new mutual fund schemes that collectively amassed over Rs 27,000 crore while the domestic mutual fund industry saw an unprecedented influx of new investors in July, with a record 1.2 million additions, the highest since December 2021.

The industry has welcomed a remarkable 2.1 million new investors in just June and July, fuelled by a wave of new fund offerings (NFOs) in popular themes. While  investors believe that spreading their money across a large number of mutual funds is a safe way to manage risk. However, financial experts warn that this strategy can backfire, leading to "portfolio fatigue" and hindering returns.
 

Pitfalls of excess:

•  With too many funds, keeping track of performance, fees, and rebalancing becomes a burden.
•  An overwhelming number of choices can lead to analysis paralysis, hindering proactive investment decisions.
•  Spreading investments too thin can dilute returns and potentially underperform a well-diversified portfolio with fewer holdings.

Financial advisor Value Research recommends a streamlined approach:

• Evaluate Performance: Regularly assess each fund's long-term performance against its category average and benchmark.
• Exit Underperformers: Don't be afraid to exit funds that consistently underperform.
• Focus on Impact: Remove investments that don't contribute significantly to your overall portfolio goals.

 

"You can start by churning the long-term underperformers. However, this should be a standard exercise done irrespective of having these many funds. So, evaluate each fund's long-term performance against its category average and benchmark performance. Exit the ones that have done poorly consistently..Lastly, you can exit investments that do not impact your portfolio due to low allocation. An allocation of at least 5% should be meaningful. So, you can sell funds that make up less than that. Any period of good performance wouldn't drive up your returns, since exposure to those funds is negligible," added Value Research.

Each fund in the portfolio should serve a purpose. 

"Four largecap funds in the portfolio will not add much value to the portfolio. You can expect a lot of overlap of stocks in the portfolios of these funds. Not all four will likely be the best- or worst-performing largecap funds. With four largecap funds, you will get a middling performance. For such performance, you are better off putting your money in a simple largecap index fund," said Deepesh Raghaw, a Sebi-registered investment advisor. 

Steps to declutter your portfolio:

Determine Your Asset Allocation: Decide on the ideal proportion of large-cap, mid-cap, and small-cap funds based on your risk tolerance and investment horizon. Less is more: Decluttering your mutual fund portfolio for better returns 

"Say, 50 percent large cap, 30 percent midcap and 20 percent small cap. Then pick up funds to fill the structure. Not the other way around. With such a structure, your fund selection will be more thoughtful and will have a greater purpose," said Raghaw.

Select Funds: Choose funds within each category that align with your investment objectives and have a proven track record.
 

Regular Evaluation: Monitor your portfolio's performance and make adjustments as needed.

For investors with a simple approach:

Index Funds: Consider investing in diversified index funds to gain exposure to the broader market.

Ignore Noise: Avoid getting swayed by short-term market trends and focus on your long-term investment goals.