A portfolio with too many funds is difficult to manage and it makes decision-making tough
How many mutual funds (MF) do you have in your portfolio? With a MF software at disposal, analysing a portfolio with too many funds is not that complicated.
A portfolio with many funds is difficult to manage and it makes decision-making tough. If poor performance of a fund does not affect your portfolio meaningfully, you will likely not touch that fund. You will remain stuck with insipid investments.
Most investors do not start with many funds. The number of funds usually increases with time. You start with Fund A and Fund B. After a few years, you realize Fund C and D are flavour of the season. You stop investing in Funds A and B and start investing in Funds C and D.
And it is not just about chasing performance. Your thought process might change too. Today, you are bullish on largecap funds or say the pharma sector. You add a couple of pharma funds to the portfolio. After a few months, you start liking the prospects of the information technology (IT) sector or midcap stocks. You add a couple of IT and midcap funds to the portfolio. Then, banking or small cap stocks. The number of funds keep rising.
There is nothing wrong per se in adjusting your portfolio according to your outlook. The problem is that most of us do not get the timing right. You do not want to move into a sector that starts underperforming once you get in. However, doesn’t that usually happen? Money chases performance. If a particular sector or fund is doing well, the investors start routing more money towards those sectors or funds. Eventually, the mean reversion sets in and the performance is usually much below expectations.
From the point of view of number of funds in the portfolio, the problem is that once a fund gets in, you do not throw it out. Irrespective of how the fund is performing or how you think about the underlying stocks, such funds do not ever find their way out.
Why? Firstly, the inertia.
Secondly, you do not want to exit a fund until you have at least broken even. You do not want to book loss. And when the fund eventually breaks even, it is doing well. And you want to hold on for a while to ride the good performance.
Thirdly, exiting the old funds is a decision. And any decision challenges you with “What ifs”. What if Fund A starts performing well immediately after you exit the fund? And this might happen. And nobody wants to live with regrets. Better still, don’t do anything and let the funds be in the portfolio.
You repeat this cycle a few times. And you have 12-14 funds in the portfolio.
This is just for equity funds. You need debt funds too in the portfolio.
How to reduce the number of mutual funds in the portfolio?
Remove any fund whose exposure is less than 5% of the portfolio. If a fund is less than 5 per cent of the portfolio (equity funds) and you are not even adding to the fund, you must exit such fund. And do that ruthlessly.
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.
Decide the portfolio structure first. 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.
Some investors simply have a couple of diversified index funds in their portfolios. If you are such an investor, you are happy and content. They ignore noise, which is aplenty in the financial services space. They do not care about the theme, sector or the fund in vogue today.
(The writer is a Sebi-Registered Investment Advisor)