Good or bad? Mutual funds that buy too many stocks

History throws up conflicting examples. On the one hand, you have the legendary Peter Lynch's US-based Magellan Fund that bought a whopping 1,400 stocks and yet gunned out over 29 per cent annualised returns over a 13-year period, which prompted even the great man to once remark: "No wonder, I'd gotten a reputation for never having met a share I didn't like."

And on the other end is the riches-to-rags story of Morgan Stanley Growth Fund, famous for being the first foreign fund that launched in India and infamous for holding about 300 stocks in its portfolio at one point before exiting the country in tears.

With the past throwing up such a fractured mandate, we decided to look at present-day funds in India and whether such bloated funds can generate alpha.

Finding fatty funds
First and foremost, we went looking for actively-managed diversified equity funds in India.

Of 248 such funds, there are eight funds that look extremely stock-heavy. In fact, more than a third of the money has been invested in stocks with less than 1 per cent allocation in their portfolio.

But of them, two funds of WhiteOak and HDFC Multi Cap are too new to the market, and we felt it would be unfair to judge them on their recent performance.

And so, we present to you the five funds with a long tail (industry jargon for funds having too many stocks in their portfolio).

Their performance
Convention says if you have a high conviction in a particular stock, you will invest more money in it, right?

Right... wrong... or perhaps maybe.

Right, because ABSL Small Cap Fund 's strategy of cluttering its portfolio is yet to pay off, failing to even beat its benchmark (the small-cap index).

Wrong, because despite holding one hundred and sixty nine stocks(!), Nippon India Small Cap Fund looks like an absolute star, beating its benchmark every year by a handsome margin.

And maybe, because the other three have performed mostly in line with their respective benchmark, performing 1-2 per cent better than their respective benchmark indices.

Did long-tailed funds beat the benchmark
Negative numbers indicate a fund's underperformance, and vice versa

Deliberate strategy?
Not really.

At least not with Nippon India Small Cap. Because the better it has performed, the more money it has got from investors, compelling the fund to try and find quality stocks. Hence the reason the fund has a long tail.

Generally, this 'winner's curse' drags a fund's performance, but that has not yet been the case with Nippon India Small Cap.

Likewise with most of the other funds on the list. Increasing investor money has compelled them to look for other stocks since it is impractical to keep putting money in the same stocks that have previously worked for a variety of reasons. (Stock price appreciation and valuation increase pop to mind).

Having said that, it is a head-scratcher as to why small-sized funds - such as the ABSL Small Cap and even the fairly-new WhiteOak funds - have a long tail. Or maybe it is to do with quality, not quantity for these fund managers.

Also read: India's longest-serving fund managers and their performance