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.
FOMO
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.
Demography
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.
Culture
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)
USA
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 info@themutualfundguide.com
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