Diversification is not about investing in mutual fund schemes with different names

What exactly is diversification? Can I have a diversified portfolio by simply spreading my money across different mutual fund schemes?

Read my article on the above subject here ...

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The English translation is as under:

Diversification

“I diversify my investments across many mutual fund schemes. I have investments across different fund houses.” Mentioned an investor. Very often you come across investors, who use technical terms without understanding the real meaning of the term.

In this case, one needs to check whether the objective diversification was really achieved. For that purpose, let us look at what diversification means.

Diversification is a strategy to allocate the investments across investment options, which are inherently different from one another. This difference must be in the behavior of the investment option. Different investment options exhibit different behavior patterns due to the influence of various external factors. Let us understand this through some examples:

·      When the Indian Rupee appreciates against global currencies, import-oriented companies benefit, whereas export-oriented companies see reduction in their revenues per unit sold. When the Rupee depreciates, the export-oriented businesses do well, but costs of import-oriented businesses go up, thus reducing their margins.

·      When interest rates move up, short-maturity bonds lose less and start earning higher soon. During such a period, long-maturity bonds lose a lot of money. The long-maturity bonds gain a lot when interest rates move down.

·      When the economy is doing very well, stocks rise in price, whereas bonds suffer as interest rates start to move up. However, when the economy goes down, stocks plummet and the central banks get into action. They reduce interest rates, which push bond prices up.

As you can see in the above examples, there are different investment options that have opposing influence of the same external factors.

When you invest in such different alternatives, you are immune to changes in that particular factor. For example, if you invest in an import unit and an export unit, you are immune to changes in the exchange rate (assuming the foreign currency is same).

Since we are discussing investing through mutual funds, the investor need not get into the details of the business of each and every company; as that job is done by the fund management team. However, if one wishes to invest through mutual funds and ensure proper diversification, one may look at different types of mutual fund schemes, e.g. invest across market capitalization, viz. large-cap schemes, mid-cap schemes, etc. or invest across asset categories, viz. equity funds, debt funds, liquid funds, gold funds, or across geographies, viz. funds investing in Indian markets as well as fund investing in global markets, etc.

Simply diversifying across different schemes may not be a true diversification.