When celebrating Diwali – the festival of lights – it’s a usual practice to clean up, declutter our homes and offices.
It’s said that cleaning and clearing allows for the passage of light, making the environment bright and permeates positivity and brightness.
This rationale can even apply to your mutual fund portfolio as well. Cleaning up and decluttering your portfolio can potentially brighten your financial future. This shall help you align your investments with the envisioned financial goals.
In this day and age, where we are subject to a plethora of mutual fund schemes as well as other investment avenues.
So, it’s possible that you have overcrowded your portfolio. And in such a case, there are good chances of even an overlap in the schemes you are holding.
By conducting a portfolio cleanup exercise, you can prevent that overlap and ensure that all your investments are well-diversified, so that optimal returns can be earned.
What is overlapping in mutual funds?
Overlapping is a situation where you are holding schemes with similar investment mandates or characteristics, plus their underlying portfolios may be similar.
The overlap may not be limited to securities or stocks held, but also in terms of their weight in the scheme’s portfolio and sector composition.
This exposes you to concentration risk and may weigh down the returns you would earn. The returns may be skewed to a few stocks, sectors, and investment styles.
You see, while diversification is the basis tenet of investing, excessive diversification without assessing if it’s truly serving its objective, proves self-defeating.
Thus, optimal diversification is necessary – and not buying each and every scheme out there in the name of diversification. You should prevent mutual fund overlap, as far as possible, is an efficient way to achieve optimal diversification.
Portfolio cleanup
Today, you have online portfolio overlap screeners or tools to check the mutual fund overlap in two or more schemes.
However, be mindful not to compare apples with oranges. Meaning don’t compare a large cap fund with a mid cap fund and/or a small cap fund.
Similarly, avoid comparing flexi cap funds with a multi cap funds or a value fund with a growth-oriented fund. The investment mandates of these funds are different.
A sensible like to like to comparison, i.e. comparing schemes with the respective categories and subcategories, is necessary for meaningful examination.
If the underlying portfolio overlap of two or more schemes within the same category and subcategory is more than 60-55%, suitable action is warranted.
You can avoid or lessen the mutual fund overlap by doing the following:
- Reduce multiple schemes from the same category and sub-category. Hold no more than 1-2 schemes from each category.
- Cut down the number of schemes from the same fund house/fund manager as they are likely to follow similar investment styles/strategies across schemes.
- Redeem schemes that do match your risk profile, broader investment objective, financial goals, and your asset allocation plan.
- Reduce schemes with a high proportion of overlap in their portfolio characteristics – stocks, sectors, their weights, etc., as they may not be able to add much value.
- Cut down on schemes that have been consistently underperforming relative to their benchmarks, despite holding them for enough time. Avoid making this decision just on 6-month or 1-year returns.
- Optimise the size of your portfolio to about 10-15 best-performing and suitable schemes.
Your objective in this cleanup exercise should be to hold mutual fund schemes that are unique ones aligning with your investment needs or goals.
This exercise also needs to be done recognising the market environment; it cannot be done in silos.
For example, now amid trade wars, looming geopolitical tensions, macroeconomic uncertainty, and stretched valuations, a higher allocation to largecaps makes sense rather smallcaps and midcaps.
The margin of safety is certainly not comforting in smallcaps and midcaps, and hence it’s best not to get carried away in these stocks.
Conclusion
When a review and cleanup are done sensibly and systematically, keeping emotions at bay, it ensures that your portfolio is optimally rebalanced and reset as per the asset allocation best suited for you.
This potentially improves risk-adjusted returns, liquidity, and the chances of accomplishing your envisioned financial goals.
As a thumb rule, your entire investment portfolio – mutual funds, stocks, fixed income instruments, etc. – should fit on one single page. This can lighten up and reduce the burden of managing it.
When building a portfolio, ask yourself whether you are ‘investing in line with your needs and risk profile’ or simply adding to the clutter by doing it in an ad hoc manner.
As you celebrate Diwali as a mark of a new beginning, take conscious steps to build a bright financial future.
Step into the new year ahead with wisdom and be a thoughtful investor.
Happy investing.
Disclaimer: This article is for information purposes only. It is not a stock recommendation and should not be treated as such. Learn more about our recommendation services here…
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