Should you diversify investments across mutual fund houses?

The word diversification connotes various things to different investors. It can vary from diversification across companies to diversification across sectors and asset classes. The reason diversification is stressed so much in investing is because it helps reduce the risk of investment.

For many, diversification also extends to investing in different mutual fund companies. This means that besides investing in various asset classes, you should also invest in funds offered by different fund houses. Nevertheless, is it worth diversifying your investment into asset management companies?

One of the reasons for diversification is to protect from any losses arising due to a collapse in the value of the investments. In case if you have invested in only one AMC and for any reason, it goes bankrupt your losses in investment will be contained. However, there is a fundamental difference between diversification between asset classes and AMCs.

Assets may lose their value significantly for many reasons, but AMC's losing their value is a distant possibility. The reason being when you hold mutual funds, they are typically held in trust on behalf of the investor and are not assets of the mutual fund company or brokerage firm itself. For this reason, it is highly improbable that a mutual fund company will fail and thus cause investors to lose money. Even in case of bankruptcy, AMC’s creditor does not have any claim on fund’s assets to pay AMC’s debt obligation. Fund’s assets will remain in the custody of the fund’s custodian and hence, even if the fund house is bankrupt and is sold, the funds of the investors remain protected. The assets are still accessible to customers through the custodian.

Therefore, if you want to diversify your portfolio, it should be across fund styles and market caps. Diversification across fund houses is not going to reduce your risk.