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Focus on Mutual Funds Research Team | Posted On Tuesday, April 07,2009, 01:34 PM

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Focus on Mutual Funds



Equity Funds

According to the Value Research Data, out of 137 only 18 have diversified equity funds and these 18 have outperformed the BSE Sensex for the year ending October 3. Many of these are sectoral or theme-based funds and have crushed the top indices because their particular sector or theme has done healthy over this period. This leaves only about 10 diversified funds that have better the Sensex greater than the one year period, an extremely bad number by any standards

The one-year time frame is essential because in this period there was a sharp modification and an equally spectacular recovery, and most funds, it appears from the results, were caught sleeping. To be more reasonable, the diversified category also includes many sector and speciality funds where the Sensex is not the right point of reference. However, below market return must upset investors.

The clear explanation for this below average performance is that these funds hold extreme too many stocks. The fact is that the principle of mutual fund investing is diversification. An individual investor is habitually unable to build a portfolio that eliminates unsystematic risk, the possibility that some stocks may not perform up to hope. He, thus, pools his savings with those of others through mutual funds to acquire a well-diversified portfolio.

The difficulty is that mutual funds often go overboard and invest in portfolio that may includes lot more stocks than what is required to achieve significant risk reduction. Even though, there is no agreement, studies suggest that a portfolio of about 20 stocks is good enough to achieve sufficient diversification. Subsequently, the decline in risk is not in keeping with the addition of more stocks. Any addition of more shares from these levels only averages out performance without proportionate reduction in risk.

Why do funds invest in so many stocks even when benefits are suspect and portfolio tracking becomes difficult? It could possibly be for the terror of underperformance. While good performance may not be satisfied through increased inflows, investors are prone to drag out from funds that under perform by a larger edge. It is this risk averseness on the part of many fund managers that they tend to invest in extreme too many stocks, which helps them report at least average performance. That being the case, does it not makes sense for investors then to invest in index fund and obtain positive explosion market returns?

If investors are pleased with market returns then it is most excellent to go with index fund. But if they are eager to take the risk of achieving better returns than the market then they have to select funds correctly. Mind you, this is not similar as suggesting sectoral or theme-based funds. In such kind of funds, the investor is still uncovered to unsystematic risk of his sector or theme not performing. We are still in the field of diversified funds that to a large extent reduce risks associated with investing in few stocks.

A focused fund that is suitably determined in few stocks is more likely to outperform the market. Usually, such focus is only viewed in small or medium-sized funds. Large funds, by nature, are tempted to invest in a lot of stocks. In the present scenario, if we leave out the sectoral and theme-based ones, we discover that funds with high portfolio focus have outperformed the others. The Rs 100-crore Reliance NRI Equity fund, for example, has over 40% of its portfolio in five stocks. And by and large, at last count, the fund had over 85% of its mass invested in just 14 stocks. It gained 50% in the past one year. In distinction, on August 31, in excess of Rs 2,000 crore Reliance Growth, an average performer over this phase, had about 80% of its mass invested in 38 stocks.

Fact is that it is easy to pierce holes in this theory as over the one-year time frame, the most horrible performing fund has a high degree of concentration. But, this criticism only bolsters the fact that a concentrated portfolio stands a better prospect of delivering high returns than a stretch out one, just as it could under perform extensively. As a result, investors seeking high returns from their funds would do sound to go with fund managers that are willing to take risks and have a performance record. Such funds may be losing at times, but are likely to more than make up with cushion results, if held for a adequately long time.

On this account, Kalpana Morparia, the Vice Chairman of the insurance, securities and asset management of ICICI Group have shared with press meet tat Indian mutual fund industry is still not explore to the depth. There are some sprouting sectors like off-shore funds, Public Sector Units which are recently allowed to invest in certain category fund schemes and foreign funds investing in India. All these which are mentioned helps in expanding Mutual Fund Industry

Appropriate asset allocation, effective diversification and suitable fund selections are some of the essential goals that every investor should wish for in a mutual fund portfolio. Whether an investor is in one of the various stages of asset accumulation or in asset withdrawal, these goals are mandatory for mutual fund portfolios to be successful. Nevertheless, an investor can encounter many roadblocks or pitfalls in the hunt to attain these goals. The rest of this article examines three of the most common obstacles and offers suggestions on how to avoid them.

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