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The Problem Lies Within

An over-large & haphazard portfolio has a far bigger impact on your investments than external negative events…

We are now coming close to the end of a year which has not seen any sustained period during which investors could be relaxed or happy, or be looking forward to whatever is happening to their investments. Mutual fund investors, in particular, have been looking for advice and reassurance. This is expected. They feel that with the equity markets doing so badly, the affect on their investments must be bad.

This isn't actually true. I mean, certainly people's investments haven't made too much money, but the reason is not what they think it is. The reason is mismanaged (or unmanaged) and overly complex investment portfolios. My impression is based on the portfolios that are sent to Value Research for the ET Now show as well as for the 'Ask Value Research' feature on ValueResearchOnline.com. Here's an outline of one typical portfolio. The total value is about Rs 80 lakh. There are 19 equity funds in it, one income fund and 28 stocks. Amazingly, the 28 stocks add up to just 3 per cent of the total portfolio, and of the 19 funds, just one fund is 34 per cent of the total. As it happens, the best-performing fund in the portfolio has a weight of just 8 per cent.

The total effective rate of return of this portfolio is 6.8 per cent p.a. Over the same period, identical investments made in a Nifty-tracking fund would have yielded 14.5 per cent. There were a number of reasons why this portfolio has performed so badly. One, bulk of the investments were done through a huge SIP that ran for years in a really bad fund that the investors' banks' 'wealth manager' sold him. Secondly, the investor paid only very intermittent attention to the portfolio, and then generally to pull out investments when the markets had tanked and to restart them when they had risen.

However, what really encapsulates the problem is the very knowledgable query that he had posed. He wanted to know that since the European crisis looked like lasting a long time and growth in India was being deliberately slowed down by the RBI, how should he restructure his portfolio? This would be almost amusing, if it hadn't been so sad. I mean, this man is his own Europe and his own RBI, rolled into one. The problem is that he had no idea about the real shape of his portfolio. The large number of investments and the huge number of transactions (over 1500 in this case) have an exponential affect on the effort required to understand what's going on.

This is not an unusual problem. An over-large and haphazard portfolio is the number one threat to real-life investment portfolios, far exceeding the impact of external negative events for many investors. This portfolio is pretty typical. Slightly better, but just as forbidding is one where the fund quality is not an issue but the humongous size is. I looked at another portfolio the other day, where an investor had almost twenty equity funds, in a wide range of quantities. They were all fine funds and individually, they were all worthy of investments. However, if you go to a restaurant where every dish is good, you can't eat everything. This portfolio was doing OK but was unmanageable. If you have twenty funds, then you have to keep track of all, monitor that no fund has declined in quality and so on. There's no point to having so many funds, it doesn't achieve anything that four or five wouldn't.

Having over-large portfolios is a problem that specially seems to affect people who know a little bit, but not enough about investing. Portfolios have to built bottom up but they can only be understood top-down, starting with basics like their breakup into broad asset classes like debt and equity. I hope to write about doing top-down analysis in the near future. It does sound like a bit work and it is—but not much. If you want hands-off investing, you should probably go for something like the post office, which will give you 8.5 per cent p.a. That's a whole lot better than what the gentleman above managed to earn after doing over 1500 transactions in equity and equity funds.