Diversifying your MF portfolio

Diversification is a strategy that is used to mitigate portfolio risk. One can diversify one’s overall investment portfolio by investing in various asset classes such as equity, debt, gold, real estate, etc. Within these asset classes, there could be diversification by allocating funds among various categories, such as market caps (small, mid and large) in equities, tenures (short and long term) and instruments (FDs, bonds, liquid funds, etc.) in the case of debt, and so on. But how does one diversify a mutual fund portfolio?

Diversification in mutual fund investments can be achieved in three ways, namely, asset classes, market caps or sectors and fund houses. Let us briefly understand these diversifications.

In the case of asset class diversification, an investor needs to invest in mutual funds investing in different asset classes. Mutual fund houses offer different schemes for investors with different risk profiles, return expectations and time horizons. Hence, equity mutual funds are for investors with high risk appetite and high returns expectations, while debt funds are those that invest in debt instruments that carry lower risk and offer lower returns than equity funds. So is the case with gold ETFs and real estate funds.

Market cap or sectoral diversification entails investing in mutual funds that invest in companies having different market capitalisation, viz. small-cap, mid-cap and large-cap. Investments in small-cap and mid-cap companies carry higher risk but can offer higher returns, whereas investments in large-cap companies ostensibly offer lower returns at lower risk. Sectoral funds take exposure to companies operating in a one or two sectors, hence the risk is high and the returns could be higher.

Investors can also diversify their risk by investing in schemes of multiple fund houses rather than investing in schemes of one or two fund houses. Apart from the different investment styles followed by various fund houses, the professional experience and core competence of the fund managers come into play in determining the risk and returns on investments.