Benchmark of schemes

If you are a mutual fund investor, it would help you in having a diversified portfolio of funds. Diversification does not mean only investing in a number of schemes to minimise your mutual fund's portfolio risk. If you want to achieve true diversification, you need to invest in schemes having different stock holdings/securities, benchmarks, market risk factor, MF categories, etc. Therefore, whenever you are building up a diversified portfolio, you should look at all these parameters so that you can achieve significant improvements in the portfolio and thereby increasing your returns potential and decreasing risks while having the right asset mix.

“Diversification basically means investing in a manner that failure in one security or an economic slump affecting one of them will not be damaging to your portfolio,” said Abhinav Angirish, Managing Director, Abchlor Investment Advisor.

Here are few things you should know how investing in different mutual fund schemes helps in minimising risk.

Understand the allocation of investments

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Investors think that their work is done once they have invested in a mutual fund, but actually, that’s not the case. While investing, proper diversification can be achieved while making the selection of schemes. “Going by the principle of diversification, it is important to allocate one’s investments in various options rather than limiting to one or a few. One should be cognizant of the fact that combination of equity and debt funds is similar to other hybrid funds (Balance, Hybrid, Dynamic Asset Allocation), with the possible exception of tax benefit in hybrid fund categories. The allocation between debt and equity funds can be managed by choosing between strategic asset allocation and tactical asset allocation,” said Anjaneya Gautam - National Head - Mutual Funds, Bajaj Capital.

You may also read: Understanding diversification and how it creates a less-risky portfolio

Know the various stocks holding

Dhaval Kapadia - Director, Portfolio Strategist, Morningstar Investment Advisers Ltd said that while constructing a mutual fund portfolio, it is important to hold unique funds within an asset class which would enable an investor to harness the benefits of diversification. This could be done by evaluating parameters such as the fund’s investment style, the correlation between funds, stock overlap, etc. The objective should be to establish a specific role for each fund to play in the overall portfolio by selecting funds that are clearly different from one another, rather than similar or redundant ones. “Holding funds with different stock holdings or low portfolio overlap provides diversification benefit and would typically help in reducing the risk of the portfolio and potentially it improves the risk-reward rather than maximise return,” he said.

Have funds of different AMC’s

Every asset management company (AMC) designs their own scheme having certain investment objective. Choosing funds from different AMC’s can also help in reducing risk as the investment objective differs from company to company thereby returns may vary even though most of the stock holding remains the same between two schemes of different AMC. Also, call taken by different fund managers while managing their funds varies which in turn can reduce the overall risk in your portfolio.

Investment horizon should vary

The investment horizon of two different schemes can also reduce the risk in your portfolio because the investment objective differs from scheme to scheme. Most importantly, you should link your investment to a specific financial goal. Combination of asset class level and fund level diversification will ultimately help in bringing down the overall risk of the portfolio while investing money with a different time horizon in two particular schemes.

You may also read: Why you should invest in multiple funds to mitigate portfolio risk

Analyse the benchmark of schemes

Every mutual fund scheme has their own benchmark for say CNX 50, BSE mid-cap, BSE 100, etc. which means that the stock holding belongs to the companies which are listed either in NSE (National Stock Exchange) or BSE (Bombay Stock Exchange) and accordingly, the risk varies as per the benchmark of the scheme. Therefore, one should try and have different schemes in their portfolios with different benchmarks. Having schemes from different AMC with the same benchmark may not give you true diversification.