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Diversification in mutual funds should include different investment styles, not just categories and AMCs.
Understanding and incorporating different styles of investing during mutual fund selection is critical.
For years, the golden rule for mutual fund investors has been diversification. The common wisdom is to build a portfolio with a mix of funds from different fund categories and asset management companies (AMCs). But what if this approach gives you an illusion of diversification, leaving your investments exposed to the concentration risk?
The reality is that you could own funds from different categories and AMCs, but if they all follow the same investment strategy, your portfolio may not be truly diversified. The crucial, often-missed layer of diversification is the investment style.
The Challenge
Think of building a portfolio like assembling a cricket team. To win a cricket match, you need a strategic mix of batsmen, bowlers and all-rounders. Likewise, to build a winning mutual funds portfolio, it is important to have a mix of funds with different investment styles.
The problem for most investors is that they often believe they have a well-diversified portfolio when they invest across categories and AMCs, ignoring the investment style. But what they do not realise is that by doing so, they may probably end up having funds following a single investment style. A single style exposure could often lead to significant portfolio underperformance when that style underperforms.
Why Does Style Diversification Matters?
For an average investor, seeing past the fund’s name or category to understand the manager’s true investment style can be difficult. This lack of information is a significant hurdle. It prevents investors from making informed decisions and building a resilient portfolio that can perform well across different market cycles.
Understanding and incorporating different styles of investing during mutual fund selection is critical. Styles like Value (buying undervalued stocks), Momentum (riding on recent performance), and Quality (investing in fundamentally strong companies) behave differently under various market conditions. A smart combination of styles can help reduce drawdowns and smooth returns over time.
A recent report studied funds across various categories and analysed the performance as well as portfolios of funds of the last five years to reveal interesting insights. It highlighted that portfolios with significant value and momentum tilt have outperformed over the past five years. For instance, the ELSS category saw most funds showing high exposure to either Value or Momentum style of investment. On the other hand, most funds with string bias towards Quality style of investing underperformed.
Advisors, distributors, and AMCs play a crucial role in helping investors recognize and assess the underlying style exposures in their portfolios. A combination of varied investment styles, investors can reduce unnecessary risks and build stronger portfolios.
The mutual fund industry is now moving toward greater transparency in style attribution and risk profiling. For investors, this shift is a powerful opportunity to rethink diversification—not just across categories and AMCs, but across investment styles.
Authored by by Nilesh D Naik, Head of Investment Products, Share.Market.
The views expressed in this article are those of the author and do not represent the stand of this publication.
Varun Yadav is a Sub Editor at News18 Business Digital. He writes articles on markets, personal finance, technology, and more. He completed his post-graduation diploma in English Journalism from the Indian Inst…Read More
Varun Yadav is a Sub Editor at News18 Business Digital. He writes articles on markets, personal finance, technology, and more. He completed his post-graduation diploma in English Journalism from the Indian Inst… Read More
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