Rs 74 lakh crore AUM, 241 million folios — Are you holding too many mutual funds?

Investors often grapple with the question of how many mutual funds to include in their portfolio. Excessive diversification is a common mistake, leading to a crowded portfolio that doesn’t necessarily decrease risk. The Indian mutual fund industry, currently managing an asset under management (AUM) of Rs 74.41 trillion, sees numerous investors falling into this trap. The rise in mutual fund folios to 241.3 million, including nearly 190.7 million retail investors and high net worth individuals, indicates a strong reliance on mutual funds for wealth creation. However, adding too many schemes can cause overlap, concentrating risk rather than mitigating it. “You know, we think diversification is—as practiced generally—makes very little sense for anyone that knows what they’re doing…it is a protection against ignorance,” Equitymaster noted in a report. 

It noted that a balanced approach suggests holding no more than 5 to 7 unique equity schemes as part of the core portfolio. This includes a mix of large cap, flexi-cap, value, and contra funds, making up 65-70% of the portfolio. 

The satellite portion, comprising 30-35%, could include aggressive hybrid and mid-cap funds, with small-cap funds for those with a high-risk appetite. This strategy is aimed at achieving an investment horizon of 7-8 years or more. The inclusion of tax-saving mutual funds, such as Equity Linked Savings Schemes (ELSS), can also be considered for tax efficiency under the old tax regime, allowing deductions up to Rs 1.5 lakh annually. 

Source: Equitymaster

For a well-rounded portfolio, it is advisable to include around four debt funds. These are not risk-free like bank fixed deposits and should be chosen based on liquidity needs and investment horizon. Options such as banking & PSU debt funds or dynamic bond funds cater to different timeframes. For shorter durations, liquid funds offer capital preservation and liquidity through investments in Treasury bills and short-term debt securities. Additionally, gold funds, either through ETFs or savings funds, serve as a hedge and store of value, particularly during economic uncertainties. 

The tactical allocation within a portfolio can be enhanced with a multi-asset fund, providing exposure to equity, debt, and gold, while some funds even include silver ETFs, REITs, and overseas equities. This flexibility allows fund managers to dynamically adjust allocations based on market conditions, potentially earning risk-adjusted returns over a 3 to 5-year period. Overall, investors may consider a total of 13 to 15 mutual fund schemes, depending on their risk profile and investment goals, ensuring each addition aligns with their strategy and does not duplicate existing holdings. 

In conclusion, the focus should be on quality over quantity when selecting mutual funds. Avoid investing based on external suggestions or past performance, as these do not guarantee future returns. A mutual fund portfolio should be crafted with a clear understanding of one’s financial goals, risk tolerance, and the time frame for achieving these objectives. A well-structured portfolio, with carefully chosen schemes, can optimise returns while maintaining manageable risk levels.