KNOWLEDGE CENTRE Mutual Fund Basics / What Is Mutual Fund Portfolio Concentration?
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What Is Mutual Fund Portfolio Concentration?


Concentration is a good thing to have as it helps you achieve a lot in life. However, when it comes to investing, it is the least advisable feature to have.

Portfolio concentration in mutual funds occurs when you invest in mutual funds that have a large concentration of stocks of one company or sector. Concentration may also result of investing in mutual funds that invest in capitalization companies that are similar to your previous mutual fund investments or stock investments.

What are the effects of portfolio concentration on your investments?

The key factor to a healthy investment portfolio is diversification and not concentration. Diversification reduces risk and improves earnings potential, whereas concentration does the exact opposite.

One of the main purpose of mutual funds is to minimize the investment risk by means of investing the pooled funds in various instruments so that the risk is reduced. The task of maintaining the balance within the mutual fund portfolio is extremely difficult and that is also, why, rather than managing your portfolio, you invest in mutual funds wherein the portfolio is managed by experts in the domain.

Before you commence investing, it is critical to carry out detailed and thorough financial planning to ensure you choose products that suit your life goals and objectives.

How can you avoid portfolio concentration with proper planning?

It is advisable to start your planning with your dream goals, as this sets a higher benchmark for yourself and keeps you motivated to achieve it.
Based on your financial goals and the investment horizon to achieve these, you will be able to determine the amount of savings that you need to start with. This will also depend on the instrument you choose to achieve the particular goal. So, choose wisely after comparing:

• The initial investment required
• The earnings potential of the instrument
• The risk involved
• The priority of the financial goal that you are setting it up for

You do not want a critically important financial goal to be relying on the earnings and performance of a high-risk investment. Nor do you want to compromise on the goal fund amount by relying on a low-risk or no-risk instrument.

When carrying out the financial planning with these four in mind, you will automatically realize the importance of diversification in your investment portfolio.

How to diversify your mutual fund portfolio?

As discussed earlier, the principal aim of a mutual fund is to diversify the risk of investment by clubbing together instruments of different risk levels and related earnings potential in a portfolio.

Now let us understand the different reasons for which this diversification could go down, become concentration, and create serious risk in the investment portfolio.

1. Reducing human bias while investing

All mutual funds are managed by individuals that are experts in investment instruments. Thus, the selection of the securities in the fund is directly related to their perception of risk involved in the same and the earnings potentials thereof. A particular manger might be sector partial and choose too many equities or debts from the same sector such as information technology (IT), oil and gas, or automobiles. While another fund manager may be theme-partial and may concentrate on commodities. You should always keep track of the concentration levels of your portfolio, even in your mutual funds and decide if it is time to switch funds.

2. Accounting for macroeconomics factors

The interest rates play a key role in the performance of both equities as well as debt instruments. There are particular instruments that are highly sensitive to interest rate fluctuation, while there are others that are sensitive to Gross Domestic Product (GDP) performance. If the mix of your mutual fund portfolio is concentrated in this manner, then it is time to rebalance it.

The bottom line is that the diversification or concentration of your mutual fund and investment portfolios should not be determined based on a particular:

• Sector or theme
• Macroeconomic factors
• Set of companies

In case of sectoral funds, you are already concentrated on a particular sector and its performance is linked to the performance of the sector. Thus, in this case, the only diversification you need to concentrate on is the number of companies that you are invested thereof.

Given the volatility of the equity markets, it could happen in the course of rebalancing that, you or the mutual fund manager end up buying instruments of the same company, sector, theme, or dependency based on its excellent performance. In the quest to earn maximum returns you could end up with a highly concentrated fund that was once, well diversified. Thus, you should be mindful of the same when rebalancing your portfolio.

ARQ, our proprietary investment search engine, can efficiently help you track the diversification and concentration of your fund portfolio and the performance thereof. As a core highlight of our Angel Bee mobile application, ARQ also provides you with recommendations and reports that are free of any human bias and based on thorough analysis of the past performance of the instrument and the impact thereof on the portfolio.


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