1. Investors’ corner: Is over-diversification your problem? Check this out

Investors’ corner: Is over-diversification your problem? Check this out

Chasing the latest product that has delivered the maximum return is one habit which investors are unable to overcome.

By: | Published: April 14, 2017 2:36 AM
In equity mutual funds, investors consider investments in multiple schemes of a category to de-risk the portfolio.

Chasing the latest product that has delivered the maximum return is one habit which investors are unable to overcome. And most often than not, this chase has been futile for most investors. Remember the craze for gold in the years 2007 to 2013. It moved from 9,500 per 10 gm levels to above 30,000. It was like a frenzy and majority of the investors got in, post 25,000 levels.

In real estate, the desire to emulate your peers and friends and buy the next plot is rampant. The process gathered steam between 2009 to 12. Then investors have fixed income instruments like bank fixed deposits and debt mutual funds and also direct equity exposure through mutual funds and stocks.

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Over-diversification

Why is there a need to have a slice of every asset class or the desire to run after a particular asset class. Both are extremes. So either concentration or over-diversification is the approach.

Most investors have a concentration of assets today in real estate. And a minority in equity as an asset class. And those who chase the latest fad, want a piece of everything . The approach is not concentration or diversification.

Misconception

In equity mutual funds, investors consider investments in multiple schemes of a category to de-risk the portfolio. However, a closer examination reveals, that the portfolio across the multiple schemes are similar with variations in sector allocation.

For instance, Scheme A would have 14% allocation to financial services and 9% allocation to FMCG sector. Scheme B would have 12% allocation to financial services and 11% allocation to FMCG sector. What is different is the name of the scheme. Also it gives a mental comfort to the investor that the investments are not concentrated in one scheme but across different schemes.

The reality is that the portfolios across the scheme are similar. De-risking is not followed in reality, it is actually ‘over-diversification’ in schemes and ‘concentration’ of portfolio. Similar observations can be noticed in other asset classes of one’s investment portfolio.

Approach

As an investor, how can you do away with both over-diversification and concentration? Is there a process to ensure that you do not fall into either trap?

Investment should be made as per your needs, your goals and the time horizon which you are looking for. If you need liquidity, you need to plan the investments accordingly. Invest in products which you understand and will be comfortable to hold at all times of the economic cycle. Allowing the flexibility of liquidity is important. Owning real assets like precious stones, gold or real estate is fraught with liquidity issues and there is a possibility of distress sale due to cashflow needs.

Do seek to understand the products that you investment in. Remember its your money and only you can take care of it. The product structure should not overrule your needs or understanding.

Understanding the perils of both over-diversification and concentration is the key in the investing journey. It does not matter if you are a victim of the above. What is more important is that you realise your mistake and make a course correction based on your need and requirements.

The writer is managing partner, BellWether Advisors LLP

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