Second Best is Always Best | Value Research Don't pay any attention to diversified funds doing worse than some other type of investment
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Second Best is Always Best

Don't pay any attention to diversified funds doing worse than some other type of investment

For at least a year now, diversified equity mutual funds are having trouble keeping up with the Sensex. There have been a number of articles and analyses pointing out this fact and the general tone has been that this proves, in some way, that diversified equity funds are not a good investment options. Financial advisors too have noted this and have adjusted their pitches accordingly. The actual phenomena is of course, a side effect of some large cap companies doing better than all other parts of the equity markets.

The funny thing is that for well over a decade now, ever since there have been a substantially differentiated set of equity mutual funds in India, the previous paragraph could have been written with minimal modification. There is always some part of the market--either by capitalisation or by sector--that is doing better than diversified funds. It could be financials or technology or infrastructure or small caps or mid-caps or whatever.

If you were to just keep an eye on such headlines without paying too much attention to them, you would gradually gather the impression that being diversified must be the worst investment strategy in the world because, clearly, diversified portfolios are always doing worse than something or the other.

Why then, if one looks at long-term returns, diversified funds are overwhelmingly better than other types of investments? The reason should now be evident to anyone who is thinking this through. We've basically defined the advantages of diversification. A diversified portfolio is always second best, so to speak. However, being diversified, it always encompasses whatever is the best. As other parts of the equity market rise from bottom to top and back again, diversified portfolio stay somewhere in the top half and thus manage to come out trumps in all but the shortest of time frames. It's sort of like the investing equivalent of the tortoise and the hare fable.




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