Is your investment portfolio really diversified?

Ankur KapurFinqa.in Most financial advisors would recommend you to diversify your investment portfolio. When executed properly, diversification is a time-tested method for reducing investment risk. However, too much diversification also known as over-diversification can be a bad thing. Many investors take the diversified portfolio prescription seriously. And they end up buying many investment instruments simultaneously. But in reality they do not diversify. To understand this better let us look at couple of examples: 1. Owning more than two mutual funds within any single investment style category

Some mutual funds with very different names can be quite similar with regard to the investment strategy and underlying investments. Investing in more than two mutual funds within any style category generally reduces the rate of diversification achieved by holding multiple positions. Let’s assume that you have a monthly SIP in two large cap funds such as Axis Equity Fund and UTI Equity Fund. Upon analysing top 10 holdings of both the funds, you will find that 60% of the companies are common between both the funds. You may be thinking that you are investing in two different funds, but your approximately 60% investments are going in same set of companies in both funds. You lack diversification when you invest in similar products. When you are constructing your investment portfolio, you should select funds that have substantially different underlying. A mix of large cap, mid cap funds or funds employing different approaches to stock picking may offer you meaningful diversification. One can also look at mutual fund schemes investing some money in shares listed on stock exchanges overseas to attain diversification. 2. Excessive use of same asset class in different vehicles

When you look at various schemes from investment point of view, you should understand each product’s portfolio composition. For example, you may be investing in gold exchange traded funds (ETF) and also a gold fund; the asset class exposure will be gold in both these schemes. You are better off investing just in one of them - gold ETFs. Similarly, if you are investing in a large cap equity fund and also direct equity, there may be layer of duplication. For example, if your direct equity includes Reliance and Infosys, there is a very high possibility that your investments in large cap equity fund too are invested in these shares. This overlap does not offer any diversification.

Many investors save money in the form of fixed deposits, National Saving Certificates, PPF and tax free bonds. Interestingly, most of the investors think that they are investing in four different products but practically they are just investing in one category - bonds. Therefore, you must analyse your portfolio for any excessive exposure to one asset class across various investment vehicles. It is important for you to be on the lookout for such cases which appear to offer diversification, but in reality lead to duplication in your investment portfolio. Working with your financial advisor to understand exactly what is in your investment portfolio and why you own it is an integral part of the diversification process. Once you do away with duplication, you can identify real opportunities that can offer you meaningful diversification. In the end, you'll be a more committed investor, too.