Funds with fewer stocks tend to do less well

When it comes to the number of stocks your mutual fund (MF) hold, less is not more.

Equity MFs with fewer stocks tend to outperform peers, according to an analysis by Business Standard. In fact, the lower the number of stocks a fund has below 30, the more likely it is to underperform other equity funds.

BS looked at data for equity funds with less than 30 stocks across one-, three- and five-year periods. There are 46 such schemes, according to information sourced from MF-tracker Value Research. They have underperformed in each of the three periods.

These funds have generated average returns of 5.07 per cent over a one-year period. Their returns over three years and five years have been 2.54 per cent and 3.34 per cent, respectively.

The average returns on 250 schemes present in the equity segment were 5.64 per cent over one year, three per cent over a three-year period and 5.25 per cent over a five-year period. An equity MF scheme, on average, has 42 stocks in its portfolio.

The trend holds true for schemes where the threshold has been lower than 30 stocks as well. In fact, the returns were generally seen to be lower for schemes with less than 25 stocks and 20 stocks than they are for schemes which had 30 scrips as the cut-off mark.

Recent moves where blue-chips such as Infosys and Hindustan Unilever have moved around 20 per cent in a day because of results or an open offer have hit fund managers. J Venkatesan, fund manager – equity, at Sundaram Asset Management Company, suggested recent volatility was a good reason to increase the number of stocks in one’s portfolio.

“Generally one feels that with 30 stocks, one would have diversified away market-risk. But under the current volatility, the number of factors moving the market are too many…we are now in a listless and polarised market, divided between two extremes…It is better to have more stocks,” he said.

The Sundaram Select Focus fund used to have a 30-stock limit. This has since been increased to 35-40, he said.

Ramanathan K, executive director & chief investment officer, ING Investment Management India, agreed that large moves in a single day might have contributed to fund managers looking to include more stocks in their portfolios. “In the past three to four months, there has been a lot of stock divergence, based on company-specific events,” he said.

He added it was difficult to decide on a fixed number of stocks. “Ideally, the stock composition of a portfolio should be between 35 and 45 stocks. There is no mathematical formula to this; it is more based on empirical evidence. Larger funds might choose to have a greater number of stocks to manage liquidity issues,” he said.