Equity mutual funds invest the corpus in shares or equities of different companies. Their potential to generate returns compared to other fund types makes them a popular investment instrument. If you have recently started your journey as a mutual fund investor, you may have been already advised to diversify your portfolio if it is based on equity mutual funds.
But have you ever wondered what the opposite of a diversified portfolio is?
In investment terminology, it is known as a concentrated portfolio. Before you continue to start more SIP plans to build your investment strategy, let us help you understand more about this aspect of investments.
What is a concentrated portfolio, and how does it work?
A concentrated portfolio refers to one that consists of only a few securities with limited diversification. Such a portfolio has 20-30 securities or even less. In terms of equity mutual funds, it refers to the schemes that hold a few stocks and higher exposure to individual stocks.
In other words, the more concentrated a scheme’s portfolio is, the higher is the risk that its returns can deviate from the benchmark - either towards significant returns or great losses.
Concentrated equity mutual funds hold a fewer number of stocks and take higher exposure to them with the intent of generating higher returns. If fund managers identify particular stocks that are expected to perform well in the future, they build higher exposure in these stocks to earn significant returns. Many of them also believe a concentrated strategy would work well in range-bound markets within which most of the stocks trade within a limited range while only a few gain.
Due to the underlying concentration, these funds could be highly volatile and may suffer from underperformance over a certain period.
Advantages of concentrated portfolios
The primary benefit of selecting equity mutual funds with concentrated portfolios is that it increases the chance of potential gains, although there is equivalent risk involved.
Who should invest in equity mutual fund schemes with concentrated portfolios?
Suppose you, as an investor, have planned for a long-term investment horizon in mind and possess a high-risk appetite. In that case, you can consider investing in schemes that have concentrated portfolios. The only thing you should keep in mind is to limit the proportion of your overall investment portfolio in such schemes.
Ideally, the equity schemes with concentrated portfolios should only cover 10-20% part of your portfolio. Also, you should prefer investing via SIP plans in these schemes.
Who should not invest in schemes with a concentrated portfolio?
The decision to not invest in any specific type of funds is primarily based on the related risk factor. Since there is risk involved with concentrated schemes, new investors are mostly advised to avoid them. A better investment approach for beginners is to start with diversified funds — whether large-cap or multi-cap.
Similarly, investors with a short-term investment horizon or those with a low-risk appetite are advised not to try their hands in concentrated equity mutual funds.
It is easy to assume that many investors drool at the wealth created with concentrated portfolios. Such examples also inspire many of us to see equity mutual fund investments as the most legitimate way to create a corpus. Therefore, it is essential to understand the features of specific schemes and seek professional help before you make any investment decision.
The information herein is meant only for general reading purposes and the views being expressed only constitute opinions and therefore cannot be considered as guidelines, recommendations or as a professional guide for the readers. The document has been prepared on the basis of publicly available information, internally developed data and other sources believed to be reliable. The sponsor, the Investment Manager, the Trustee or any of their directors, employees, affiliates or representatives (“entities & their affiliates”) do not assume any responsibility for, or warrant the accuracy, completeness, adequacy and reliability of such information. Recipients of this information are advised to rely on their own analysis, interpretations & investigations. Readers are also advised to seek independent professional advice in order to arrive at an informed investment decision. Entities & their affiliates including persons involved in the preparation or issuance of this material shall not be liable in any way for any direct, indirect, special, incidental, consequential, punitive or exemplary damages, including on account of lost profits arising from the information contained in this material. Recipient alone shall be fully responsible for any decision taken on the basis of this document.
Mutual Fund Investments are subject to market risks, read all the scheme related documents carefully.