Does your portfolio have a fat head and a thin tail? Or a big middle? Or is it just long and tail-like, like a snake? Ideally, it should be a short and thick snake. The problem of fat heads and thin tails is simple: investors have enough funds to be diversified, but they are not invested in these in the right proportion.
A meta-analysis of portfolios in the VRO My Investments shows that well over half the value of a typical portfolio comes from only around 25 per cent of the total number of funds that it is made up of. So while investors may have a lot of funds, most of these are there in name only, while one or two funds form a large chunk of the portfolio. The most extreme examples are portfolios with 20+ funds with a single fund weighing in at more than 50 per cent.
Why this happens is obvious from the analysis. We tend to invest in different funds at different times, when we may have different amounts of investible surplus available. This means that the weightage is influenced by our prosperity rather than the funds' characteristics. Moreover, we tend to start Systematic Investment Plans (SIPs) when we have more money, thus perpetuating a higher inflow into some funds. In general, most people's income rises with time. Thus, if they get interested in newer funds later in life, these funds get invested in disproportionately.
Out of sight, out of mind
A large part of the problem is that many investors do not detect this happening. An overwhelming number of investors do not check the common account statement which comes from the depositories, and so do not have a consolidated view of their investments.
The awareness that they might have too much invested in one or two funds can only come from viewing a consolidated statement which is properly updated and has the calculated weightages. Fortunately for VRO users, our My Investments does that for free. The 'Overview' view in the 'My Investments' section shows you such a consolidated view of each fund's weightage as part of your total investments. Even a glance at this will immediately make the problem apparent. For instance, you may have eight funds, but four of these may add up to just 21 per cent of your portfolio. One of them may constitute only 3 per cent of your investments! No matter how wonderful this fund may be, you will never realise any meaningful returns from it. On the other hand, you may have a fund that constitutes 47 per cent your portfolio. This puts paid to the idea of diversification. If this fund does badly, it will drag everything down with it.
The solution is to invest in a small number of funds, perhaps four or five. And make sure that none of them comes to dominate your portfolio.
This story was first published in September 2013.