How to diversify your Mutual Fund portfolio

The term ‘diversification’ is almost synonymous with Mutual Funds. This is all the more significant when your Mutual Fund portfolio is completely equity based. 

The idea behind having a diversified portfolio is to diversify your risks, this follows the ‘’Do not put all your eggs in one basket’’ theory.

Diversification has its own challenges but many if not all are usually investor made and not market made.

Diversifying your Mutual Fund portfolio does have its perks, that has never been questioned but over diversifying can adversely affect your portfolio and this has very rarely been addressed.

Is your Mutual Fund portfolio really diversified?

Let’s find out

Axis Mutual Fund Case Study

2018 was a very commendable year for Axis Mutual Fund as a fund house. It not only left behind its peers in various categories, it did so with some distance.

Scheme Returns (For 2018)
Axis Bluechip (Large Cap) 9.31%
Axis Multi Cap 9.16%

If you notice, there is not much to choose from the above schemes as far as their returns are concerned. This is despite them both belonging to different categories and working with different mandates.

The similarity in their returns is no coincidence but rather the result of a strategy that was synonymous to both of these schemes.

In both the Axis Large Cap as well as the Multi Cap, the top 3 sectors are the same

      a) Financial Services
      b) Consumer Goods and   
      c) IT

In fact even the difference in each sector between both the schemes is less than 1%.

As can be seen from the above images, the only difference between the Large Cap and the Multi Cap of Axis Multi Cap in the top 5 holdings is only one.

In fact the top four holdings in terms of exposure is exactly the same.

As both the above images signify, both the above schemes are manages by Mr Shreyash Devalkar.

You may think you have diversified since you have invested in both a large cap as well as a multi cap but in reality you have invested your entire amount into the same fund house, fund manager, top holdings and sectors.

So basically your entire portfolio is at the mercy of just one strategy which cannot be called as diversification.

And this is reflected in the difference of their returns being a minor 0.15 %.

Another reason for their stellar performance along with the above mentioned points is the cash holding strategy.

The above example looks good on paper only because it came off well but what if it had not?

You could argue why bother with the negative but the very idea of diversification is to diversify risks.

Imagine if the cash strategy had not gone well for Axis Mutual Fund and it backfired, you would be left pondering why both a large cap and a multi cap is down with similar returns when in fact diversification even if not being able to guard against negative returns, is still giving similar negative returns.

Is your Mutual Fund Portfolio really diversified?

Diversification should constitute the following major points:

  a)  Fund Manager
     b)  Fund House    
     c)  Scheme strategy

Fund Manager

Prashant Jain, the fund manager for HDFC Multi Cap and HDFC Large Cap along with being the Chief Investment Officer for HDFC Mutual Fund has been able to successfully enter a particular market theme when it is about take off like say the IT boom in the late 90’s.

He also has his fair share of misses like exiting Page industries early.

So therefore betting on merely one manager and expecting him to get it right all the time would be asking too much. It is therefore advisable to diversify between more than one fund manager.

Fund House

Parag Parikh Fund House and Quantum Fund House both deploy a heavy use of cash strategy (used by Axis Mutual Fund in 2018) with their schemes. Quant Fund House (not to be confused with Quantum Fund House) has very limited scope for human intervention and depends heavily on number for their schemes.

As can be seen, certain fund houses adopt certain strategies throughout all their schemes, it is therefore advisable to diversify among various fund houses in case one strategy does not work out.

Scheme Strategy

After SEBI’s decision to re-categorize schemes into various categories along with a strict investing mandate, we now have a separate Value category scheme altogether.

We have the Aditya Birla Value scheme that deploys a buying at a low rate and selling at a high rate strategy which explains its high portfolio turnover ratio of 214% as on 28th February 2019.

The Parag Parikh Long Term Equity Fund which also boasts of a value investing strategy adopts a buying at opportunistic levels and holding onto them strategy. This explains its extremely low turnover ratio of only 4% as on 28th February 2019.

Buying of Amazon shares in January 2019 when it witnessed a sharp dip is a very good example of buying at opportunistic levels.

Birla Value and Parag Parikh Long Term Equity both follow a value investing strategy but have their own interpretation of the strategy.


Fear of Missing Out or FOMO is when fear drives a buying frenzy and thereby leads to unnecessary addition in one’s portfolio. These so called best schemes can be garnered from various sources like websites, facebook groups, colleagues, relatives, business channels, online publications, etc.

First and foremost let’s make one thing absolutely clear, there are no best schemes but only well suited schemes according to one’s profile.

Some publications come out with monthly updates on these whereas the rankings of these schemes are updated on a quarterly basis.

The major issue with such an approach is that you will always find one scheme that is termed as best absent from your portfolio. You then invest in that scheme you have missed out on,this is a never ending approach since equity markets fluctuate frequently.

This approach is severely hazardous for the following reasons:

      a)  Tax Miscalculation
      b)  Losing out on compounding benefits
      c)  Unable to track a large portfolio

Frequent churning of your portfolio would mean you would have to pay an exit load along with a very complicated tax scenario. In case you hold an equity mutual fund for more than a year, you are no more exempted from Capital Gains Tax on the same.

The very idea of equity investing, more specifically with an SIP is to avail compounding benefits that equities can give. When you give up on an equity SIP to go for that best scheme, you also give up on the compounding benefits that your previously held equity SIP could give.

When you keep on adding new schemes every couple of months, this leads to a very bloated portfolio that becomes extremely difficult to track. This is all the more difficult with thematic and sectoral mutual funds which needs the timing of entry and exit to be very precise. At times having a very large portfolio leads to dilution in returns.

This issue can be easily resolved by staying true and disciplined to your goals rather than chasing returns. 

When the process is clear and clean, the results shall follow.

Axis Bluechip Fund 

Aum as on 31st January 2018 INR 1930cr
Aum as on 31st December 2018 INR 3737cr
Increase in Aum  93.63%

As you can see, the AUM of Axis Bluechip Fund saw an increase in inflow to the tune of 93.63% within a period of just 12 months.

This is primarily due to its performance during the same period, it’s not as if within the same period all of a sudden the average retail investor concluded that the scheme suits his/her risk profile. 

Unfortunately the average retail investor is still return oriented and not goal and this is reflected in the AUM of various schemes over a specific period.

This high fluctuation in AUM of schemes is more prominent in aggressive schemes that belong to categories like mid, small, thematic and sectoral.

Geographic Diversification

Geographic Diversification comes into the picture when you have a larger portfolio which would allow some allocation. The allocation amount would certainly be completely dependent on the individual and his/her needs.

When there is scope for geographic diversification, it can be divided into the following two categories:

      a)  Developed economies 
      b)  Emerging economies

India falls into category b so if you do diversify into say another emerging economy based fund like Brazil for example, keep in mind that you still have not achieved geographic diversification.

When you are investing into another emerging economy, it should be backed by strong reasons like say a sector which is not covered by the Indian economy. 

Case Study

Jupiter Asian Income Fund is a UK based Fund (not open to Indian investors) which as the name suggests, invests primarily in Asian markets (including Australia).

It bets heavily on the gaming sector with Sands China being its largest holding.

Other stocks in the gaming sector include Genting Singapore and Star Entertainment.

               ‘’Sands China is one of the only six licensed casino operators in Macau, China’s official gambling destination and now known as the Las Vegas of Asia. Sands has the most casino space in Macau and some 13,000 hotel rooms. Over the Chinese New Year, you can’t get a room for love nor money.’’ -  Jason Pidcock (Fund Manager)

The fund currently has no exposure to India (emerging market) for political and economic uncertainty. Even if you assume the above factors were not a hurdle, it is highly unlikely it would invest in India since it has no gaming structure as such. 

Yes it is an untapped business with enormous potential but there is still no legal structure in place for the same.

Even though this fund is not open to Indian investors, the reason for bringing this up was to point out despite investing in Asian markets it still can distinguish itself from other funds due to its bias towards the gaming sector and no exposure to Indian markets at all.

It therefore would have been an ideal candidate for diversification despite investing into emerging markets and thus proves as an excellent case study for how to diversify.

Many if not all emerging markets have a lot in common than one would imagine. Countries like India, Brazil, Argentina etc. all grapple with similar issues like oil imports and currency valuation.

Brazil and India are both member of BRICS, that is an association of the five major economies of Brazil, Russia, India, China and South Africa.

Developed Economies

Japanese economy being a developed economy is an interesting market because it neither provides the stability you would expect from a developed economy nor growth one would expect from an emerging market.

Every economy is affected by demography and culture and Japan is no different.

By 2014, 26% of Japan’s population was 65 years or above. It has an extremely low birth rate which can be garnered from the fact that in 2014 sale of adult diapers surpassed those for babies.

It has one of the lowest fertility rates in the world along with the highest life expectancy rate in the world.

This therefore means that a major source of public funds is spent on an age group that cannot return the favour to the economy by means of spending.

Marriages are on the decline due to high cost of raising a child and it is also notorious for karoshi (extremely long working hours). There is a higher percentage of women joining the workforce but gender pay gap continuous to be high.

Japan is home to conservative gender roles which means women are expected to quit their work and stay home with their children, this is another reason for decline in marriages.

An ageing population, lower birth rate and marriages all adds to a very sober economy.

A 75 year old will not demand a car, if there is no demand it would mean no supply which ergo means no production and employment and no disposal.

No disposal income would mean no spending which again takes us to the demand and supply cycle.

The Japanese economy provides stable growth but not the stability you would expect from a developed economy. An ageing population along with cultural challenges has meant conservative growth rates over a prolonged period as can be seen by the historic growth of Nikkei (Japanese Market Index).

It therefore does not make sense to add a Japan based fund in your portfolio when it neither provides the stability of a developed economy nor growth of an emerging market.

It would be advisable to take individual stock positions if one wants exposure to the Japanese market rather than a Japanese fund, like picking Suzuki on the Nikkei rather than Maruti Suzuki in India which is priced higher. (This is what Parag Parikh Long Term Equity did)

The US is a developed economy but unlike Japan is far more stable.
It is home some of the biggest companies in the world like Facebook, Amazon, Alphabet (Parent company to Google). These companies also have the highest R & D spend in the world since they are heavily data based.

The US and Indian markets also have an extremely low co-relative rate (less than 1%). This makes it for an excellent diversification candidate since it offers something that an Indian market cannot.

Where the US market differs from an emerging market like India is in providing stability that Indian markets cannot but keep in mind that it cannot provide you with growth rates that India can so you would need to keep your expectations at a moderate level.

As can be seen from the above image, there is not much difference between the Reliance Japan Fund and Reliance US Fund when it comes to growth but there is a massive difference when it comes to volatility. The Reliance Japan Fund falls more than a Reliance US Fund despite both being developed markets.

The US as opposed to Japan is a consumer driven economy with 70% of its economy driven by the consumption sector.It also has a higher working population, which means a higher disposable income and thereby more support to the consumption sector which in turn supports a major part of their economy.

Constructing a truly diversified Mutual Funds portfolio is hard
Staying invested in a truly diversified Mutual Funds portfolio is harder
Being content with returns of a truly diversified Mutual Funds portfolio is the hardest 

If you feel like you have made a diversified portfolio but cannot explain what diversification it truly offers then you cannot call that a diversified portfolio.

For portfolio enquiries, email us with your doubts at
Disclaimer : While due precaution has been undertaken in the preparation of this article, The Mutual Fund Guide or any of its authors will not be held liable for any investments based on the above article. The above article should not be considered financial advice and has been published only for your perusal. Due credit has been given in case wherever required, in case you feel any part violates any rights then do get in touch with us and we shall get it duly removed.  
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