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.

Understanding diversification ...

Mutual fund companies highlight the benefit of diversification. What exactly is it and how does it help one? Let us understand the meaning, benefits and limitations of diversification here ...

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Read the English translation below:

Understanding diversification

Mutual fund companies highlight the benefit of diversification. What exactly is it and how does it help one?

When we invest our money in any investment, there is a lot of work required to study and analyse the same. However, there is still a risk of one’s judgment being wrong. There is a protection available against such errors of judgment. Invest across different companies representing different industries. However, do so only after identifying good companies. This would ensure that even if your judgment is wrong in a few cases, or if things do not turn out as expected, at least some part of your investment portfolio will not disappoint you.

In reality, a well-diversified portfolio tends to protect downside even while allowing one to participate in good part of the upside.

Is there any downside to diversification?

While diversification protects the portfolio from complete erosion, there would always be some part of the same portfolio that would outperform the whole. So if you are stickler for best performance, you are likely to be disappointed, as the whole portfolio cannot beat every single component of itself.

What care should one take while diversifying?

While comparison between the portfolio and one part of the same may make the portfolio look underperforming, it is unfair to do such a comparison. If we go back to the opening paragraph, we discussed that the purpose of diversification is to protect oneself against any unexpected, negative outcome. This means, if no part of your portfolio is delivering a disappointing performance, it is not properly diversified. Imagine, if all the components of your portfolio were rising in value simultaneously, what would happen if the present situation reverses? There is a possibility that in such a situation, the entire portfolio would witness a drastic fall in market value.

The key is to invest across companies, across industries, across asset categories and across geographies. In such a case, the portfolio is most likely to exhibit smooth performance, but as we have already mentioned earlier, it would underperform some part of the market.

- Amit Trivedi

Questions regarding mutual funds - answered during the chat session today on www.moneycontrol.com

Click on the link below to read the transcript of my chat today on Moneycontrol.

http://www.moneycontrol.com/news/mgmtinterviews/chats/detail_new.php?chatid=2667

Concentration v/s Diversification : What to choose? - from the archives

Whether to follow the adage "Do not put all your eggs in one basket" or "Put all your eggs in one basket and watch the basket carefully" depends on your strengths or the lack of the same in the respective areas and this is especially true in case of investments. Amit Trivedi explains why


Read more

Equity investments simplified - chat transcript - 8th Feb, 2016

Here is the link to the transcript of the chat

Equity investments simplified

Global turmoil - what should an investor do? - an article from the archives

China has grown phenomenally in the last few decades. It has emerged as one of the largest exporting nations. However, recent times have been not-so-easy for the second largest economy in the world. Does it mean that like many other products, even the problems of China be exported to the world? Will the "Made in China" problems swarm the world like the "Made in China" products?

I don't know. However, the question in most investors' minds is: "What would it do to my portfolio?"

A couple of years ago, we had a similar scare: US credit rating was downgraded. This is what we wrote then: Global Turmoil - What should Investors do?

Th lessons are as relevant today as they were then.

Equity investments simplified - my chat on Moneycontrol

I would be doing a chat session on www.moneycontrol.com today at 4 PM, answering questions on investment in mutual funds and planning your investments

You cannot predict the future, but you can protect yourself

The track record of forecasters is not as impressive as one would like to see. So if you cannot predict, protect your portfolio.

Click here to read further ...

Transcript of chat on www.moneycontrol.com on 14th Sept, 2015

http://www.moneycontrol.com/master_your_money/view_chat_transcript.php?cat=&chatid=2497

An affordable and convenient investment option for investors

Mutual funds offer an affordable and convenient way to invest in a diversified portfolio.

To read my article in Mid-day Gujarati edition, click here

The English translation of the article is as follows:

Among the many benefits of mutual funds, we often hear about affordability. The argument in favour of affordability is that a small investor can start investing even small amounts of money. This was a big advantage when we had physical share certificates and one could not put small amounts of money into buying a “market lot” of shares. A market lot in shares was a certain minimum number of shares that an investor had to buy in order to trade in the normal markets. These lots, in most cases, consisted of 100 shares. Anything other than this market lot was known as “odd lot” and the same traded at a discount to the market lot, generally. At the same time, investing money in fixed income instruments was much easier with banks accepting small amounts of deposits and the Government promoted small savings schemes.

However, in the mid-1990s, the investment world changed with the advent of information technology and with that technology enabled solutions like electronic trading and dematerialization of securities. This allowed investors to buy even one share of a company rather than buying a market lot. Thus, investing became affordable, if one were to consider a single stock.

It is ok to keep buying single stocks if one has only limited resources. This could be a good accumulation strategy. However, this suffers from three drawbacks or limitations.

First, one may not be able to properly diversify the portfolio. Buying one share every time one has money will take a long to build a portfolio that is properly diversified. This process of building a portfolio will require a lot of planning to arrive at a proper diversification and the steps to buy the identified stocks. On top of that, one would also be required to know which stocks to buy or avoid.

Second, it requires immense amount of discipline to follow this strategy in order to accumulate a sufficiently diversified portfolio. If you need to buy 30 stocks to diversify your portfolio, it will take roughly 30 months (assuming you get a monthly salary and hence monthly savings) to do those 30 transactions. If the market prices go up and down during this period, it becomes very difficult for most to stay focused on the plan to continue buying.

Third, the weightage of each stock in the portfolio would not be a function of what one wants, but that would depend on the price of each share. While the savings over the period may be constant, the prices of different shares may not be the same. So, if you save Rs. 1,000 monthly, you can buy a share that is priced at Rs. 900. However, what do you do if the share you want to buy is priced at Rs. 3,000?

Considering that it is inconvenient to pursue such an investment strategy, which takes away precious time away from your family life and your hobbies, we must try to find a solution that is easier, convenient, effective and consumes less time.

This is where mutual funds enter. You can buy a portfolio consisting of 30 or 50 well-researched stocks (regular monitoring of the portfolio, included in the deal) for as little as Rs. 1,000 per month. Now, the only thing you need is to continue your SIP (Systematic Investment Plan).

So, go ahead and enjoy life. Leave the task of money management to a mutual fund company.

Amit Trivedi

The author runs Karmayog Knowledge Academy. The views expressed are his personal opinions.

Disclaimer: This article should not be construed as investment advice.

Who should consider investing in sector funds?

Click on the link below to read my article on Sector funds ...

http://epaper.gujaratimidday.com//epaperpdf/gmd/27042015/27042015-md-gm-14.pdf


The English translation of the article is as under:

“Which sector is most likely to lead the next bull run? How do I take benefit of the same?”

I wish I knew the answer. The fact is: while most of us do not know the answer to the above questions, many want to know. Speculation about the future events, is part of the basic nature of human beings. We all want to know the future in advance.

Whereas we may not know the answer to the first question, the second question is easy to answer. If you know which sector is likely to lead the next bull market, find out if there mutual funds available investing only in that particular sector. These funds, as a groupd, are called “Sector Funds”. The objective of these funds is to generate long-term returns by investing in companies belonging to a particular sector.

In the Indian market, we have many options available, viz. Pharma funds, FMCG funds, Banking and financial services funds, Infotech funds, to name a few.

The investor having a positive view for a sector may invest in a fund related to that sector. The critical factors for success is the knowledge of the sector prospects. In order to understand the sector prospects, you must first understand how the sector operates. Developing this understanding takes time. One’s understanding may be limited to one or two or three sectors, at most.

Since these sector funds invest only in one industry sector, they lose out on the benefit of diversification. In one of our earlier articles, while talking about diversification, we had highlighted two issues with concentrated portfolios: (1) some developments, e.g. changes in Government policy, or technological advancements, or change in public preferences may have a negative impact on the prospects of an entire sector; and (2) price movements driven by sentiments may see fall in the prices of shares belonging to an entire sector together.

In either case, anyone holding a portfolio concentrated in a sector is likely to see drop in portfolio value – sometimes for short periods, or sometimes for long. The prices of shares in a sector are likely to move up or down much more than the broader market. It is important to understand whether one has the financial and psychological ability to withdtand such fluctuations – may be deep and long.

Most of us would be better off leaving the sector selection decision in the hands of the fund manager.

Sometimes what one is trying to do is to take a view on few sectors based on Government action (or any such single factor). Your long-term investment strategy should not be changed every now and then if the Government changes the policies. In the long-term, a diversified portfolio should actually be able to withstand such changes.

Most of us are better off leaving the sector selection decision in the hands of the fund manager. You may consider investing in sector funds only (1) if you understand the secret very well, and (2) you are ok with the risks, including volatility, of the sector.

Amit Trivedi

The author runs Karmayog Knowledge Academy. The views expressed are his personal opinions.

Benefits of investing in International mutual funds

How do international mutual funds work? Are there reasons why someone should consider these funds? For details, read the article in Mid-day Gujarati ...

Benefits of investing in international mutual funds

The English translation is as under:
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Many parents aspire for foreign education for their kids. This is evident from the number of column centimeters that the education consultants’ advertisements occupy in the newspapers. In such a case, it would be worth considering the cost of such education for the parents of a young kid in high school.

Some time ago, one of the newspaper reports talked about the rise in education costs in the US. The report suggested that between 1985 and 2013, the college fees went up 6 times. This is an annual growth of 6.6%. Considering the inflation in India, this rate of price rise looks small.

However, an Indian parent planning to send the child abroad, must also add the change in the exchange rate between US Dollar and Indian Rupee (Assuming that one is considering sending the child to the US).

On December 1985, the exchange rate was Rs. 12 to a Dollar (Source: Reserve Bank of India). The same was Rs. 65 to a Dollar in 2013. Hence, the cost of education went up 6 times in Dollar terms, and almost 400 times in Rupee terms. This works out to price rise @ 13.25% p.a. over this entire period.

Any major expense in the future must be adjusted for the expected rise in price, if one wants to properly plan.

One of the ways to protect one’s investments against inflation is to invest in assets that have the potential to beat it, viz., equity. However, in the discussion so far, one of the components of this inflation is the change in the exchange rate. In such a case, it might be a good idea to invest in foreign equity funds. If a parent is planning to send the child abroad for higher studies – say ten years from now, one may consider investing in international equity mutual funds. These funds offer protection against potential depreciation in the Indian currency.

Does this mean we are expecting the Indian Rupee to go down against the world currencies? No, we do not know whether Rupee would appreciate or depreciate. It is exactly in such a situation when one is not sure that protection is required.

Today, we have a large number of mutual fund schemes available in the Indian markets that invest in equity markets across various sections of the world market.

Apart from the benefit we highlighted above, these schemes also offer the benefit of diversification to the Indian investors. Even if one does not have a goal to spend money abroad, diversification is a reason enough to consider these funds. If we look at a typical India investor’s portfolio, in most cases, the entire investment is in India – be it stocks, mutual funds, debentures, fixed deposits, post office savings schemes, PPF, real estate – everything is in India.

Although, people are expecting India growth story to continue, one is not sure if the growth path would be smooth or bumpy.

What are the options available today?

Indian investors have two options to invest abroad:

1.     Under the Reserve bank’s liberalized remittance scheme, a certain sum of money can be invested by each income tax assesse every year. However, this process is complicated and hence must be left to those who have substantial sum of money.

2.     Indian mutual funds are allowed to launch schemes that invest in securities abroad. We have today many international equity funds offering exposure to various markets, e.g. US, Europe, Brazil, China (both directly as well as through Hong Kong), emerging markets, Asian equity markets, etc.

There are two types of funds – those that buy securities directly and those that simply buy an existing mutual fund investing in such securities.

All these funds are classified as non-equity funds for the purpose of taxation and hence they are subject to dividend distribution tax, if you opt for dividends and on capital gains tax on redemption.

Consider this as a new alternative and hence tread cautiously. At the same time, it may not be wise to ignore these funds.

Amit Trivedi

The author runs Karmayog Knowledge Academy. The views expressed are his personal opinions.

Disclaimer: This article should not be construed as investment advice.