Here's how portfolio diversification goes wrong

In an interview to CNBC-TV18, Pankaj Mathpal of Optima Money Managers shared views on how a retail investor can achieve optimum level of portfolio diversification. He also picked three mutual fund schemes one can consider investing in now. 

Also Read: Retiring? Here's what you should invest in Below is the verbatim transcript of Mathpal's interview with CNBC-TV18. Q: There are several instances of people holding 15-20 life insurance policies and endless mutual funds. What is the optimum level of diversification for a retail investor, beyond which the investment begins giving negative returns. So, it is counterproductive to have that many mutual funds? A: There is no direct relation between number of schemes in a portfolio and returns but if one has too many schemes then definitely one will not be able to manage those schemes and it will have effect on return of portfolio. Insurance and investment are two different things. I will not advice anybody to invest in insurance. Insurance is to protect future income in case of untimely death of the breadwinner of the family. So, one should have a term insurance policy. In some cases one may have more than one term insurance policy also, for example if one want to protect future expenses then buy a term insurance policy with a term of 30 years considering retirement age. If one has home loan then to protect that one is buying term insurance policy for 15-20 years. Therefore, in such case there maybe more than one policy, but not too many because in case of eventuality the beneficiary will have to approach different insurance companies for claim. Therefore, one can have one-two or maximum three in some cases where one want to protect some goal like child education for five-ten years, if the horizon is that much, but not too many policies. However, sometime people buy 15-20 policies of Rs 1 lakh assured instead of that buy Rs 50 lakh term insurance or Rs 1 crore term insurance based on need but policies should be one or two. As far as investment in mutual funds, there are different types of mutual funds like equity schemes, debt schemes, gold and hybrid schemes. So, based on objective of investment, risk appetite and investment horizon, one can invest in equity, debt or hybrid but in the same category there is no point of keeping multiple schemes. These are diversified portfolios. If one is investing in stocks then I understand that investment is done in five-six stocks and not one company stock. however, in terms of mutual fund; mutual fund has 25-30 stocks in their portfolio so if one is buying 10-15 schemes that means one is over diversifying portfolio. So, one should have maximum four-five schemes in his portfolio, here I am talking about mutual funds, some fixed deposit and coming to insurance, only two-three insurance policies maximum based on term of policy. _PAGEBREAK_ Q: How do you manage mutual funds? You will perhaps have a couple of equity funds with you; you will have a couple of debt funds, balance funds. The problem is how you compare performance? A: If it is equity fund then first thing is that give some time to that fund to perform, at least six months, two consecutive quarters and even if the fund is not performing then there is some reason behind that if it is in the same category, suppose one is comparing two largecap funds and the scheme where he has invested is underperforming compared to its category then definitely he has to see. Q: Underperforming in terms of what. Underperforming in six-three month bucket; if it is still outperforming in one year bucket and a five year bucket, which is the correct time tenure to compare? A: Compared to category if the scheme is underperforming then there is some reason because if market is giving 15 percent return and scheme is giving 5 percent return then what is the reason behind that. Therefore, if one is comparing largecap with midcap then there is no comparison. However, talking about same category one is comparing two largecap funds and one is realising that the scheme is underperforming then definitely switch to some other better performing scheme. So, as I said risk adjusted returns are important and if I talk about standard deviation, beta and r-squared, which becomes difficult for common investor to understand. Therefore, go to moneycontrol.com, a comparison is available for all the schemes and one will also get information on which scheme to hold or sell or buy. So, if one can takes the advantage of that then that is a best choice for a common investor. _PAGEBREAK_ Caller Q: I am earning 60,000 per month. I need to know where and how I should invest? A: First thing is that an investor should decide goals whether long-term or short-term, investment horizon and based on risk appetite he can decide. For short-term, if somebody wants to invest for one-two years then debt funds are better in that investment horizon. However, if somebody wants to invest for more than five years then he should have some allocation of his portfolio in equity because in long-term equity performs better compared to other asset classes. So, I will advise you that if you are investing for different goal then you should allocate in equity, debt and some allocation in gold also. As of now you have invested in insurance policies. Insurance is not an investment product. Insurance should be bought only to protect risk, it should be avoided otherwise. Investment in mutual funds makes sense for an investor who does not have much knowledge about equity market or other investment products. There are equity funds, debt funds, gold oriented funds where you can invest and through systematic investment plan (SIP) if you invests then it is a better choice because you get benefit of rupee cost averaging. You can start investing through SIP in Edelweiss Absolute Return Fund, which is a hybrid fund. In bond fund category ICICI Prudential Dynamic Bond Fund is my suggestion. One is large and midcap fund – UTI Opportunities Fund. So, in these funds you can start investing through SIP considering your goal and investment horizon. SBI Dynamic Fund is also a good fund in dynamic fund category. Even if you have a very small investment horizon then you can chose Gilt fund also to invest like SBI Magnum Gilt Fund, short-term plan, Religare Invesco Gilt Fund. So, these are the funds you can have in your portfolio.