Too many stocks or too little, both spell danger. Create one which is balanced
When mutual funds restrict their portfolio to 20-30 stocks, investment advisors and fund houses call it a concentrated portfolio. Take the example of DSP BlackRock's new fund, Focus 25. When launched, this scheme will have only 20-30 stocks in its portfolio. The scheme information document says this will have a "non-diversified" portfolio.
To diversify adequately, an MF typically holds 40-70 stocks in its portfolio.
For an individual investor, having these many stocks in the portfolio is a nightmare. It is difficult to keep track of developments in each company in case of a high number of stocks.
Does an individual investor need to add as many stocks as an MF to diversify the portfolio? Investments experts and financial planners say a person does not need to go beyond 20-25 stocks in a portfolio to call it well-diversified. Obviously, this should not be a random selection. An investor needs to restrict each stock and invest across sectors.
"Diversification is, essentially, spreading the risk. More stocks ensure the portfolio is not skewed towards one sector or company," says Om Ahuja, head - wealth management and strategy, Emkay Global Financial Services. In case there is a concentration, a correction in such stocks or sector would severely impact the returns of the overall portfolio.
An investor can diversify his stock collection in three steps. To begin, the person needs to decide on the number of stocks he or she can track.
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Less than 15 stocks in a portfolio would mean a risky, or concentrated, portfolio. Essentially, such portfolios have a concentration either in very few stocks or in a particular sector.
To make sure a sector exposure is not too high, financial planners advise capping investments in each sector. Preferably, an investor should not invest more than 10 per cent in a single sector.
A final step is to cap investments on individual stocks. "Ideally, no individual stock should be more than five per cent of the overall portfolio. However, in case an investor is very sure about a company's future, he can allocate seven-eight per cent of the overall portfolio investment," says Brijesh Dalmia, financial planner and founder, Dalmia Advisory Services.
For individuals taking direct exposure to equity, 20-25 stocks means they are well-diversified. This is, however, not true for someone making a portfolio of MFs. This is because these funds have a ability to track the 40-70 funds they keep in the portfolio. These professionals follow updates on the company every hour and can change the portfolio, depending on the company prospects and news flow.
"In the country, the investible stock universe is 300-400 stocks. Taking bets of 15-20 per cent stocks from this universe is reasonable. This is one reason why diversified equity MFs have been able to give high returns over the years," says Apoorva Shah, executive vice president and fund manager, DSP BlackRock Mutual Fund.
For an investor using MFs to create a portfolio, the maximum funds should not be more than six. This would include debt fund, monthly income plan schemes, equity-diversified funds and sector funds.
"The core of the portfolio should be two-three equity diversified funds. One or two sector funds, wherein the investment amount is small, can be included. For stability of the portfolio, a person adds debt funds. This investment should not be made in more than two funds," says Dalmia.
His logic is that two-three equity diversified funds means the number of exposures to individual companies increases drastically. If an investor puts money in two equity-diversified funds that hold 50 stocks each, there are chances that the exposure to individual stocks can be over 60-70 stocks. This is because 15-20 stocks could overlap.
"Also, when a person picks two-three funds, he is essentially not only diversifying the number of stocks but also investment style fund managers and philosophy of fund houses," says Dalmia.
