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Sunday, August 17, 2014

Can investments in only 3 funds provide adequate portfolio diversification?

The short answer to the question is: Yes, provided you are willing to spend a little time in choosing the funds. How little is little time? That will depend on your internet connection speed and search skills.

Visit valueresearchonline.com. About half-way down on the home page are ‘Research Tools’. You can use the six tools provided to narrow down on funds you may want to invest in. It took me less than 15 minutes, even though my ADSL connection is pretty slow.

The ‘Fund Ranking’ tool allows you to check the performance of various categories of funds over different time periods. It was used to randomly select 3 funds. (Well, not so randomly because only funds ranked 5-star and 4-star were considered for selection.)

The table below shows the top 10 equity holdings of the 3 funds:

Quantum Long Term Equity HDFC Mid-cap Opportunities Reliance Tax Saver
HDFC Aurobindo Pharma TVS Motor
Bajaj Auto Mindtree ACC
Infosys Supreme Industries Alsthom T&D
Voltas IPCA Laboratories SBI
ONGC Torrent Pharma Titan
TCS AIA Engineering Wipro
Indian Hotels SKF India Honeywell Automation
Tata Chemicals Bayer Crop Science Schneider Electric
ACC Axis Bank Siemens
ING Vysya Bank Bank of Baroda Bharat Forge

The main reason for choosing these 3 funds was the lack of duplication in their top 10 holdings (except ACC). Effectively, any one investing in these 3 funds is investing in 29 different stocks covering sectors like financial institutions (both private and PSU), IT, chemicals, 2-wheeler, engineering, pharma, energy, consumer durables, hospitality and construction.

The absence of FMCG, 4-wheeler and metals (though AIA Engineering can be considered a ‘metal’ sector company) may be considered a drawback for adequate diversification. But these are 3 suggested funds to prove a point. Investors are free to choose other funds keeping in mind sector diversification and non-duplication of stocks.

Note that a large-cap fund, a mid-cap fund and a tax saving fund have been chosen for further diversification. Debt funds now have a tax implication that makes them less attractive than balanced funds. A gold fund can be added to the list, if required.

So there, you have it. Investing in individual stocks of the 3 funds to build a portfolio may cost an arm and a leg. But regular monthly investments of your savings in the 3 funds can help you build a well-diversified portfolio of top-performing stocks over time.

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