Mutual Funds: Investing in Diversified Equity Funds is a safer option

Investors perpetually suffer from the lack of diversification. Diversification provides an edge to the portfolio which maximizes returns and minimizes risks. While Large Cap funds are considered to be a relatively safe option, the Mid and Small cap Funds are considered to be comparatively risky and volatile. The classification of these funds depends upon the market capitalization of the stocks that the fund owns. However, what if along with moderate risks one could also invest in the funds already diversified? Let us explore Diversified Equity Mutual Funds.

What are Diversified Equity Funds

Diversified equity funds invest across market capitalizations and sectors. Such active diversification ensures the negative performance of one sector does not affect the entire portfolio and increases the possibility of making a sustainable return. These funds aim for medium to long term capital appreciation and suitable for investors having moderate risk profile and investment horizon of at least 3 - 5 years.

The investments of these funds could be vertical in nature where various sectors and a mix of the various market caps are considered for investments. Diversified Equity funds with vertical investments tend to be more diversified than horizontal investments as it provides sectoral and market cap diversification and provides better cover against risk. Across the industry diversified funds are also known as Multicap Funds, Flexi Cap Funds or Large and Midcap Funds.

Having too many Large Cap Funds in your portfolio could stagnate your investments returns. Investing solely in Mid and Small Cap Funds could make your portfolio volatile and risky. Diversified Equity funds are that middle path which allows you to invest in the all market caps through one fund.

Benefits of Investing in Diversified Equity Funds

• Stability in Bull and Bear Markets:

  Diversified Equity Funds comprise of all markets cap stocks. Large cap stocks due to high end market capitalization tend to be stable in bear markets and show moderate appreciation in bull markets. Mid and small cap stocks respond to market stimulations. While, they show higher appreciation in bull markets, their depreciation is in sync with the bear markets. The differences in the performance of these market caps get balanced in the Diversified Equity Funds. In a bear market the mid and small cap stocks have a tendency to be volatile even if the large cap stocks shows moderate depreciation, thereby maintaining a steady balance. Due to this stability it allows investors with a varying risk appetite to park their investments in these funds.



• Reduces the Need to Diversify:

  Financial planners and advisors keep emphasising about the need to diversify your investments. It is said that diversification in various asset classes determines the return of the portfolio and not the individual funds. Investing in Diversified Equity Funds reduces the need to diversify your portfolio as you choose an already diversified fund depending upon your investing needs and risk taking ability. As an investor if you are looking for stability in your investments, you could allocate a larger portion of your investments in Diversified Equity Funds and the remaining in Small and Mid Cap Funds. However, If you are an aggressive investor and ready to take high risk for long term appreciation then Mid and Small Cap Funds could be ideal investments for you.



• A universal Appeal:

  The fund has a component to appeal to all kinds of investors: the risk takers, the safe player and the flexible investor. It also reduces the need to diversify. Hence, as an investor if you like to manage your own portfolio then this reduces your need to diversify to a certain degree. It provides stability to your portfolio along with a return range of moderate to high.

How to pick a Fund

As an investor this is probably one of the most crucial decisions to make. There are too many schemes within a same category and all of them sound equally appealing. Each either has a high rate of return or promises to deliver so in future. All of this could be intimidating and confusing. Needless to say there are various factors that have to be taken into account: the historical performance, the returns generated against the category and the benchmark index. Let us examine the nuances of these aspects and make this process of selection a little easier for you.

Compare the Fund Returns against the Diversified Fund Category Return and Benchmark: A fund that has been in market for a considerable period time of time will have a track record of returns over the years. Compare that return to the returns of the Diversified Equity Mutual Fund Category and the Benchmark associated with the Fund. The category returns are projected after taking into account an average of returns of all the schemes under that category. For example, if the return of a Diversified Equity Fund over ten years has been 22% annualised and the category return over the same period has been 18% annualised then the scheme has outperformed the category returns.

Now, you need to check the performance of the fund against which it has been benchmarked – For example, S&P BSE 100, S&P BSE 200, CNX 200 and CNX 500 etc. Majority of the Diversified Equity Mutual Funds in India are associated to these 4 Benchmarks. If you find that the fund chosen by you have outperformed both – The Category Returns and the Benchmark then you can consider the fund for investing.

Let us check returns of some the Diversified Equity Funds versus the various Benchmarks –

Source: Funds selection based on CRISIL Diversified Funds Category

Fund and Benchmark Returns source: Valueresearch

You will notice that most of the Diversified Equity Mutual Funds shown above have beaten the various related Benchmarks. However, please also note that the above is not a comprehensive selection of funds as we have chosen few funds only for explaining to our readers.

Check the consistency of the Chosen Diversified Equity Fund: A Diversified Equity Mutual Funds can consist of large, mid and small cap stocks in its portfolio. Hence, the fund managers can choose stocks from different sectors and market caps. As an investor it could be difficult for you to track the sectors or stocks within your chosen fund. Therefore, to check the consistency of the returns you should look at two things - the historical returns of the fund and the volatility of the selected fund across different market cycles.

Conclusion

Equity as an asset class is vast and has various categories of investments. Diversified Equity Mutual Funds being one of a kind where investors need not individually diversify the various investments. It is that kind of equity mutual fund where one can invest and expect returns ranging from moderate to high and suitable for beginners and moderate risk takers. There are no iron clad promises in investing. A fund no matter how safe or risky could always surprise you and Diversified Equity Funds are not an exception. Historically it has been seen that long term investments in Diversified Equity Funds have beaten the returns of Bank Fixed Deposits, Gold and PPF returns with a decent margin. However, to choose the right fund according to your risk taking appetite and the time horizon, you should consult a financial advisor. Read more about various funds under Diversified Equity Funds category here.