How To Reduce The Number Of Funds In Your Portfolio

Many fund investors fall into the trap of becoming 'fund collectors,' accumulating a vast number of schemes in their portfolio - sometimes as high as 40 or even 50! This phenomenon stems from various factors:

Chasing Past Returns: Investors may be tempted to chase funds with impressive past performance, leading to an overloaded portfolio.

Mis-Selling: Unsuitable funds might be sold to investors, resulting in unnecessary collection.

ELSS Accumulation for Tax Savings: The annual hunt for new ELSS schemes (often with a 3-year lock-in) can quickly pile up.

Investment FOMO (Fear Of Missing Out): Fascination with hot themes or new fund offers (NFOs) can lead to impulsive investments.

The consequence? An overly complex portfolio. But the issue goes beyond manageability. Let's delve into the specific problems associated with holding too many funds.

Why Excess Funds in your Portfolio Can Hinder Your Returns

While diversification is the cornerstone of successful investing, having too many funds can dilute your returns and complicate management:

• Dilution of Returns: Imagine holding five equity funds, each with a 5% allocation. Even if one fund performs exceptionally well, its impact on your overall portfolio will be minimal. Studies have shown that investors who started investing in 2002 have, on average, 18 Mutual Fund schemes in their portfolio, those who started investing in 2010 have 12, and the investors who started in 2018 have 6. This not only dilutes potential gains but also increases fees.

• Portfolio Mimicking the Index: With a plethora of overlapping funds, your portfolio might inadvertently start resembling a broad market index. This negates the benefit of active management, where fund managers aim to outperform the benchmark.

• Management Complexity: Monitoring and rebalancing a portfolio overflowing with funds becomes a cumbersome task. This can lead to neglecting your investments altogether, potentially hindering your long-term goals.

Strategies for Streamlining Your Portfolio

Now that we understand the downsides of holding too many funds, let's explore techniques to streamline your portfolio:

Exit the Underperformers

Evaluate the performance of each fund against its benchmark and peers. Funds consistently trailing the index or its category average for an extended period (ideally, 2 years or more) might be underperformers. Analyze the reasons behind their underperformance – is it a temporary blip or a structural issue? If the underperformance seems persistent, consider exiting the fund and reinvesting in a better performer.

Here's an example to illustrate:

Let's say you hold two large-cap equity funds (Fund A & Fund B) in your portfolio, each with a 10% allocation. You've noticed that Fund B has consistently underperformed Fund A and its benchmark for the past two years. After careful analysis, you decide to exit Fund B. Here's what you need to consider:

Exit Load: Mutual funds often levy exit loads for redemptions within a specific lock-in period. Factor in this charge before exiting to avoid eroding your returns.

Tax Implications: Depending on the holding period of your investment, capital gains tax may apply when selling the underperforming fund.

Remember: The potential for higher returns from a better performing fund might outweigh the short-term cost of exit loads and taxes.

Cull Underweight Holdings: Focus on Impact

Focus on the impact each fund has on your overall portfolio. Identify funds with allocations less than a predetermined threshold (ideally 5% of your total investment). These underweight holdings likely contribute minimally to your returns. Here's how to handle them:

• Identify Minimal Contributors: Scrutinize your portfolio to pinpoint funds with allocations below your chosen threshold.

• Consolidate or Exit: Consider exiting these underweight funds entirely. Alternatively, research broader funds that align with your investment goals and offer greater diversification. This simplifies portfolio management and potentially reduces expenses by eliminating fees associated with multiple smaller funds.

Rethink Sectoral and Thematic Funds: Evaluate Risk-Return Trade-off

Sectoral and thematic funds offer concentrated exposure to specific industries or themes. While they hold the potential for high returns, they also carry significantly higher risk. These funds might be suitable for a small portion of your portfolio if you possess a deep understanding of the chosen sector or theme and have a high tolerance for volatility. However, for most investors, these funds can introduce unnecessary risk and complexity.

Here's a breakdown to consider:

• High Conviction, High Risk: If you have in-depth knowledge and a strong belief in a particular sector or theme's future growth prospects, a small allocation to a thematic or sectoral fund might be warranted. However, remember, these funds are inherently risky and susceptible to market fluctuations within that specific sector.

• Prioritize Diversification: For most investors, broad diversification across asset classes and market capitalizations remains the cornerstone of a successful investment strategy. Sectoral and thematic funds can detract from this diversification, potentially hindering long-term returns.

Do You Really Need Mid/Small-Cap Funds?

Mid/small-cap funds offer the potential for higher returns but come with greater volatility and risk. They are suitable for investors with a higher risk tolerance who are comfortable with short-term fluctuations. Here's what to consider:

• Risk Tolerance: If you're averse to significant fluctuations in your portfolio value, mid/small-cap funds might not be the best fit. Consider exiting them or reducing their allocation to a maximum of 30% of your portfolio.

• Investment Horizon: These funds are best suited for long-term investment horizons (ideally, 7 years or more) to ride out market volatility and potentially benefit from growth.

• Action Step: Analyze your risk tolerance and investment goals. If mid/small-cap funds don't align with your needs, consider exiting them or reducing their allocation.

Check Your Large-Cap Funds

Large-cap funds offer stability and growth by investing in established companies. However, their return potential might be lower compared to mid/small-cap funds. Here's how to decide:

• Investment Goals: Large-cap funds are suitable for conservative investors seeking moderate equity exposure with lower risk. If you have a longer investment horizon and are comfortable with some volatility, flexi-cap funds (investing across market capitalizations) could be a better choice for wealth creation.

• Risk Profile: If you have a compelling reason for holding large-cap funds, such as nearing retirement or a low-risk tolerance, you can retain them. However, for most investors seeking capital appreciation, flexi-cap funds offer more flexibility.

• Action Step: Evaluate your investment goals and risk profile. If large-cap funds don't align with your needs, consider exiting them or replacing them with flexi-cap funds.

Don't Be Too Indebted to Debt

Debt funds provide fixed income but with varying degrees of risk and return. Here's how to optimize your debt allocation:

• Asset Allocation: The ideal debt allocation in your portfolio depends on your age, risk tolerance, and financial goals. Consider your overall asset allocation (including fixed income investments like PPF, bank FDs, etc.) before reviewing your debt funds.

• Multiple Debt Funds: If you hold numerous debt funds without a clear strategy, it might be time to consolidate. Consider your desired debt exposure and choose funds that cater to your risk-return preferences.

• Action Step: Analyze your overall asset allocation and risk tolerance. If your debt allocation is excessive, consider exiting some debt funds to maintain a balanced portfolio.

Consider Hybrid Funds As Well

Hybrid funds combine equity and debt, offering a balance between growth and stability. Here's how to decide if they fit your portfolio:

• Investment Strategy: Hybrid funds can be suitable for beginners as they provide automatic asset allocation. Balanced advantage funds, a type of hybrid, dynamically adjust allocations based on market conditions.

• Portfolio Overlap: If you already have equity and debt funds, a hybrid fund might create redundancy. Evaluate if a hybrid fund offers a distinct advantage compared to your existing portfolio.

• Action Step: Assess your investment strategy and existing portfolio. If you lack a clear purpose for holding hybrid funds, consider exiting them to simplify your portfolio.

Check For Portfolio Overlap

Portfolio overlap occurs when multiple funds invest in the same underlying securities. This reduces diversification and can be inefficient. Here's how to identify and address it:

• Analyze Fund Holdings: Use online resources or consult your financial counselor to understand the holdings of each fund in your portfolio. Look for significant overlap in terms of stocks or bonds.

• Consolidate Duplicates: If you find funds with excessive overlap, consider exiting one or merging them into a single, more diversified fund.

• Action Step: Analyze your portfolio holdings and identify any overlapping investments. Consolidate or exit duplicate funds to streamline your portfolio.

Create Goals To Aign Your Portfolio to

Think of your portfolio as a strategic investment plan, with each fund contributing to your financial objectives. Here's how to ensure your chosen funds work together effectively:

• Define Investment Goals: Clearly define your short, medium, and long-term financial aspirations. Are you saving for retirement, a child's education, or a down payment on a house? Knowing your goals will guide your asset allocation strategy.

• Map Funds to Goals: Large-cap funds can provide stability and growth suitable for long-term goals. Mid-cap funds offer the potential for higher returns with greater volatility, making them appropriate for aggressive investors with a longer investment horizon. Debt funds offer fixed income and can help manage risk within your portfolio. Choose funds that cater to your specific risk tolerance and align with your investment goals.

Conclusion

Remember, streamlining your portfolio isn't about minimalism for minimalism's sake. It's about maximising your returns by strategically allocating your capital. By reducing the number of funds you hold, you can simplify management, focus on clear investment goals, and potentially unlock better returns.

• Review Regularly: Conduct periodic portfolio reviews (at least annually) to assess fund performance and ensure alignment with your evolving goals.

• Seek Professional Guidance: If you're unsure about streamlining your portfolio, consider consulting a financial counsellor for personalised advice.

• Invest for the Long Term: Don't get swayed by market noise. Stick to your investment plan and chosen funds for the long haul to achieve your financial objectives.

By following these strategies, you can transform your portfolio from a cluttered marketplace into a well-oiled machine, propelling you towards your financial aspirations.