Think more mutual funds mean better diversification? Here’s why your portfolio may still be concentrated

For many mutual fund investors, adding another scheme to their portfolio feels like a simple way to spread risk. But owning a larger number of funds does not necessarily mean owning a more diversified portfolio. In fact, investors can hold several schemes while remaining heavily exposed to the same stocks, sectors or market-cap segments.

Experts say investors should look beyond the number of schemes and examine what each fund actually adds to the portfolio.

“The number of funds an investor holds tells us very little about how diversified they actually are,” said Rhishabh Garg, CEO of FundsIndia.com. A mutual fund may already hold 40-60 stocks or more, he said, and two schemes with different names can still have significant overlap in their holdings and investment styles.

As a result, adding a fifth or sixth fund may simply duplicate exposures that an investor already has.

Garg said genuine diversification comes from combining assets and strategies that do not move in lockstep. He pointed to investment styles such as growth at reasonable price, value, quality, mid and small caps and global exposure, which can behave differently across market cycles.

The problem becomes more apparent when investors choose funds from different categories but do not examine their underlying portfolios.

Amitabh Lara, executive director at Anand Rathi Wealth Limited, said an audit of around 13,600 mutual fund portfolios showed that simply holding a larger number of funds did not necessarily translate into better outcomes. According to Lara, 16% of these portfolios underperformed the Nifty 50, while 86% underperformed the firm's model portfolio.

He pointed to a hypothetical portfolio comprising large-cap, flexi-cap, focused, dividend-yield, contra, value and Nifty 50 index funds. Although the investor appears to have diversified across seven different categories, the underlying exposure can remain heavily tilted towards large-cap stocks.

Large-cap funds have around 82% exposure to large caps, while flexi-cap funds have nearly 60%, focused funds around 65%, value funds about 60%, contra funds 55% and dividend-yield funds 67%, according to Lara. A Nifty 50 index fund, meanwhile, has virtually its entire portfolio in large-cap stocks.

“This shows how important it is to check each fund’s underlying exposure to different parameters to understand if an investor is actually seeing diversification in their overall portfolio,” Lara said.

Sector concentration can create another layer of risk. Lara cited a portfolio comprising SBI Large and Mid Cap, HDFC Flexi Cap and ICICI Prudential Focused Fund. Banking is the top sector across all three funds.

An investor putting ₹ 1 lakh in each could end up with roughly 27-30% of the total portfolio concentrated in banking, according to his analysis.

This means that even when the individual stocks differ, the funds could still respond similarly to a downturn in the banking sector. Investors therefore need to look beyond fund names and categories and examine the underlying sector and market-cap exposure.

There is no universal number.