Diversification as we all know at a high-level is aligning negatively correlated assets in one’s portfolio to insulate the overall performance from vagaries of any particular asset class. By including equities, fixed income, commodities and real estate one can easily get the best of all worlds but more importantly cushion against the uncertainties in any one asset class. But the role of diversification is much deeper within every particular asset class.
Diversification strategies in equity portfolio management
If we take an example of equity, then market cap diversification is one of the most common strategies followed by advisors. This strategy requires one to diversify across large cap, mid cap, small cap allocations so that the portfolio is not highly lopsided towards a particular market capitalization and again is an all-season portfolio.
Also, including a fair proportion of all market caps gives a flavour of stable growth to the portfolio. Large caps are more steady and less volatile whereas mid and small caps can give aggressive returns with more volatility. So a healthy combination of all market caps as per the risk appetite of investors can make for a great portfolio.
But beyond this – one has to also adhere to two other forms of diversification. First is to split one’s portfolio across multiple different well-known investing brains i.e. across different fund managers. One cannot be heavily skewed towards one fund house or one particular fund manager as even if they manage different funds, the underlying composition or philosophy rarely differs.
Hence, dividing the allocation amongst few highly acclaimed fund managers is a great diversification strategy. One has to be astute enough in portfolio construction to avoid duplication of funds with similar portfolio managers because rarely will it give a very different portfolio and hence just add to the number of schemes but not to the return profile.
Diversification strategies in investment styles
Last, is to diversify across differing investment styles. One has to be fairly allocated across styles of quality, momentum, growth, value, low volatility etc to gain from short market cycles within the large market phases. Factor based investing is a very popular concept internationally and this has just made its entry in the Indian market.
Mostly savvy investors capture these styles through various fund managers or fund houses who claim to adhere to these underlying approaches of investing. But it’s very difficult to find a fund which sticks to a single philosophy and is genuinely true-to-label.
Mostly fund managers resort to a blend of differing styles and in the process dilute the core philosophy. And hence to play them either one has to be smart enough to identify the right fund managers with a particular style or one can simply invest in various factor based index funds (smart beta funds) which have become very popular off-late. It’s easier and simpler to stick to these factor investing themes via the index fund or ETF mode rather than scout for such fund managers.
In nutshell, true diversification is not just at an asset level but also across different fund managers and different investing styles or philosophies. This will ensure that the portfolio is long-term ready to face any kind of market cycle or phase.
Mohit Gang, CEO, Moneyfront
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Published: 10 May 2024, 05:47 PM IST