What's diversification?
Diversification for an equity fund would mean building a portfolio that includes securities that are not affected by the same set of variables. For instance, information technology, pharmaceuticals, consumer goods, agro-chemicals, cement, steel, aluminium are completely different businesses. Depending on the country's economy, the trick is to find stocks that do not move in tandem at the same time. When you diversify, you try to ensure that at any given point of time, if a part of your portfolio is down, a larger part of your holdings should be up and overall, your portfolio is doing fine.

Why diversify?
Although investors may be carried away by the the excellent returns of a particular sector, the hard fact is that these exceptional returns cannot be sustained for long. There is no guarantee that one year's winner will be in the top category in the following year too. Nevertheless, diversification does not eliminate risk. But it helps you to reduce risk.

The enduring principles of sound investing that have served investors for decades are diversification, balance and a long-term orientation. But many investors are behaving as if there is no tomorrow. The thinking is that all you have to do is buy a single stock and watch it go up 150 per cent.

Interestingly it's not just individual investors, but mutual fund portfolio managers who are just as tempted to chase performance. They also fear that their market share will falter if they don't jump on the faddish bandwagon.The trade-off for the balancing of risk and return in a diversified portfolio is that your overall return might be lower than you could get in a concentrated portfolio. However, in the long-term, a diversified portfolio give you steadier returns. It's, however, important that a diversified fund should have a tenure of not less than 18 months. And another criterion is that IT sector should have an allocation of 35 per cent. Also, investor should pick up funds which have a consistently diversified portfolio across sectors and stocks. KP Bluechip and Sundaram Growth funds qualify both these criteria.

No wonder, in the current southward movement of the markets, these funds lost less than the average fall of the funds in the particular category (average fall was 29 per cent). Also, the standard deviation of the monthly returns of the two funds over 18 months' time period was 10.6 and 7.9 respectively, while the mean monthly return for the corresponding duration was 6.7 and 4.9. (The average monthly standard deviation and return of the select 15 funds was 11.2 and 6.87 respectively.) This reflects the risk-return trade-off.

Kothari Pioneer Bluechip Fund invests in premium companies. Launched in 1993, the fund faltered when the IPO boom went bust in 1994. However, aggressive restructuring post-1994 has helped the fund post handsome returns. An early entrant into the software sector, the fund followed a strategy of diversified portfolio across growth and cyclical sectors. The fund has given an annualised return of 33.34 per cent since launch against 5.6 per cent by the Sensex.

As on March 2000, the fund has 28 per cent stake in the software sector. While FMCG accounts for 7.6 per cent, cyclical stocks today account for 20 per cent of the net assets. The fund has 31 per cent in cash as on March 31, which will help it pick up quality stocks in the recent meltdown. In the brief post-budget meltdown, the fund lost 18.5 per cent vis-a-vis a 16.5 per cent drop in the Sensex. Sundaram Growth Fund has given an annualised total return of 30 per cent since launch against a 6.1 per cent return by the Sensex. The fund has consistently outperformed the broad market indices except during the cyclical rally in the second quarter of the year 1999.

With a diversified portfolio, the fund successfully guarded its assets in the falling markets of 1998. In the current downturn, the fund fell 24.75 per cent, far less than its aggressive peers. Currently, the Rs-29 crore fund is spread over 45 stocks. Apart from the 33.4 per cent allocation to software, the fund has exposure to media and telecom at 10 per cent and cyclicals 29 per cent. For fiscal 2000, the fund has gained 74 per cent. If the fund is able to restrict its exposure to the software sector at current levels, it can be a good option for steady growth.

-- Value Research