Diversification is the key to managing money. But, where should you start?

Why do you need diversity?

Reduces Risk: Diversification investment helps in reducing the risk of loss from a single investment or a single AMC (asset management company). For example, if an investor has a portfolio of mutual fund schemes across eight categories, a fall in the mid-cap stock segment will have less impact on his overall portfolio as compared to one who invests entirely in the mid-cap space. Is.

Provides stability in returns: Diversification investing also helps stabilize returns by spreading investments across different assets that have low correlations and may perform differently in different market conditions. In this way, an investor can benefit from the potential growth of a wide variety of assets and reduce the impact of poor performance of any one investment. For example, equity and debt have a low correlation.

It is important to be real and not optical diversification. Optical diversification is when you have multiple products that behave similarly in your portfolio. Real diversification can be achieved by having exposure to products that behave differently in different market scenarios, or products belonging to different sectors or different asset management companies (AMCs). Suppose, you have 10 funds in your portfolio, all from one AMC. This would be optical diversification as you have 100% exposure to one AMC and this would increase your AMC exposure.

how to diversify

Through different asset classes: There are a large number of assets to choose from and each comes with its own set of risk and return trade-offs and an investor can create his own basket based on his taste for risk. An investor often chooses any one of the asset classes mentioned in the table. We have tried to capture their average risk and return potential. As we can see from the two scenarios, diversification plays a huge role in portfolio performance.

Through different product categories: In a particular asset class, you have access to different products, although you need to understand whether you need all or some of them. Say, there are four equity products – direct equity, portfolio management services (PMS), mutual funds (MFs) and alternative investment funds (AIFs). If you choose all products from the same asset class, your portfolio will fail to diversify. Suppose, if you are opting for Equity MF, then you can avoid PMS as they behave in similar manner and MF is more cost and tax efficient.

Via Market Cap: There are 15 categories of MFs, out of which six are based on market cap. It is wise to select categories in a balanced manner that have been consistent in their alpha generation potential and have performed well across different market cycles. It is ideal to maintain a large-cap, mid-cap and small-cap allocation in the ratio of 50:30:20 at the portfolio level.

Via Style: There are two styles of investing, growth and value style. A fund manager following the value style will invest in fundamentally strong companies which are trading at valuations below the market level. A fund manager following a growth style will invest in fundamentally strong companies that have higher earnings growth potential than peers. The value style does well in a bull phase and the growth style does better in a bear phase. Blend style indicates that the fund manager is agile and keeps switching between styles depending on the market scenario.

Diversification is extremely important to reduce risk and increase stability in a portfolio. Asset allocation is the most important of all diversification methods. This is the most important factor when setting goals and reviewing one’s portfolio.

Firoz Aziz is the Deputy CEO of Anand Rathi Wealth