Investment

Too much diversification in mutual funds driving you to direct stocks? Here is a way out

This is a theory that has gained strength among mutual funds lately. Mutual fund managers play it too safe by diversifying a lot. That is the reason why most mutual fund schemes have been failing to keep pace with the market in the last few years. To make money, one should bet on just a few growth stocks. That is what some mutual fund investors have started doing – betting on stocks directly.

We wouldn’t bore you with the advantages of diversification here. We will first look whether mutual fund managers try to diversify too much and then we will proceed to find a way out of the situation.

A look at five toppers in the large cap mutual fund category in the last year reveals that these schemes have around 27-50 stocks in their portfolio. The number is around 21-59 for multi cap schemes, and 23-62 for mid cap schemes. Top five small cap schemes in the last year have around 20-66 stocks in their portfolio.

Also read: Moving from mutual funds to stocks? Remember these 4 points

As you can see, your theory of fund managers picking up so many schemes to playing it safe by probably hugging the index or simply by diversifying is true in some cases. However, it is not true in some cases. For example, there are schemes in all these major categories that have concentrated portfolios with around 20 something stocks.

If you probe further, you would also notice that these schemes have also taken high concentration bets. For example, Parag Parikh Long Term Fund, one of the top performers in the multi cap category, has only 21 stocks in its portfolio. Further, the scheme bets heavily on its top stocks. Its top 5 stocks make up for almost 30% of the portfolio, top 10 stocks account for almost 50% of the portfolio.

The point is: you already have choices in almost every mutual fund category if you are looking to bet on a concentrated portfolio.

And we are not yet done. We haven’t even taken a look at the focussed mutual fund category that has the mandate to invest in less than 30 stocks. These schemes also have a heavily focused and concentrated portfolio. Top 10 holdings in most of these schemes make up for almost half of their portfolio.

Sure, you will not be impressed by the information if your idea of a concentrated portfolio is just a handful of stocks. If so, you may go ahead and invest directly in stocks. But you should be aware that betting on just five to six stocks means a lot of risk and potential for high rewards. But the opposite is also true. If one of your bets fails to live up to the promise, it will drag your portfolio down sharply.

(This article is part of a series ETMutualFunds.com has started on the issue of direct investments in stocks.)

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