Diversified Mutual Funds

Diversification in mutual funds is one of the most effective ways to minimise risk and optimise returns, so you have a comfortable risk-reward outlook in your portfolio. While you can always attempt to manually diversify your portfolio, diversified mutual funds offer an easy alternative. They are inherently diversified, so you need not make the effort to curate a diversified portfolio from scratch.

In this article, we examine what diversified funds are, the different types of such funds and how they can benefit you.

What are Diversified Mutual Funds?

A diversified fund is an investment vehicle designed to mitigate risk by allocating assets across various market sectors, asset classes, and geographic regions. By holding a broad range of securities, these funds aim to reduce the impact of individual market fluctuations on the overall portfolio. In contrast to specialised funds that focus on specific sectors or industries, diversified funds offer a broader exposure to the market, potentially reducing volatility and enhancing long-term returns.

Since these funds are not concentrated either sectorally or in terms of the market cap, they give you broad market exposure. So, even if any one sector or category of investments performs poorly during a given period, the losses from this part of your portfolio may be offset by other investments.

What is diversification in mutual funds?

Effective risk management in equity mutual funds often involves a diversified approach. This entails investing across various sectors and market capitalisations to mitigate the potential negative impact of individual security or fund performance. By spreading investments across multiple funds within a portfolio, investors can cushion the effects of market volatility.

Diversified mutual funds, offered by various fund houses, provide a convenient avenue for achieving this diversification. These funds invest in securities spanning different market capitalisations and industries, offering investors exposure to a broader range of investment opportunities. While diversified funds are not entirely immune to market fluctuations, they generally exhibit greater resilience compared to sector-specific or single-capitalisation funds, which are more susceptible to concentrated risks.

Diversification in mutual fund with example

Diversified mutual funds primarily aim to reduce unsystematic risk — which is essentially risk that is specific to an asset or asset class. For example, small-cap stocks may be susceptible to market volatility. So, diversified equity funds like multi-cap funds attempt to reduce this risk by diversifying across companies with different market caps.

Diversification can also happen across asset classes. For instance, a hybrid mutual fund may distribute its capital across equity, debt and other asset categories to offset the risk in one area and the returns in another. Depending on the kind of diversification in a mutual fund, the scheme may successfully navigate systematic and unsystematic risk too.

Different types of diversified funds

Some of the different kinds of diversified mutual funds you can choose from include the following:

• Index funds: Index funds offer diversification across different companies listed on the stock exchanges. The most popular index funds replicate broad market indexes like Nifty 50 or Sensex. However, there are also diversified mutual funds that replicate other sectoral, thematic or strategic indexes. That said, index funds can be risky because they are predominantly equity-oriented.
• Multi-cap funds: Multi-cap funds, also known as diversified equity mutual funds, invest at least 75% of their assets in equity and equity-related instruments. This 75% is distributed among small-cap, mid-cap and large-cap stocks in a predefined ratio. By adopting a balanced approach and diversifying across different market caps, these diversified funds minimise the risk associated with any one category.
• Hybrid funds: Hybrid funds are diversified mutual funds that invest in debt, equity and other asset classes. The proportion of investments in these categories can vary from as low as 10% to as much as 80% — depending on whether the fund is a conservative, balanced or aggressive hybrid fund. You can choose the risk level based on how conservative or aggressive your approach is.
• Balanced funds: Balanced funds are a type of hybrid funds that invest in debt and equity classes almost equally. The asset allocation for these funds as prescribed by the Securities and Exchange Board of India (SEBI) is 40% to 60% in equity and 60% to 40% in debt. This type of diversified mutual fund distributes the capital almost equally between two contrarian asset classes, so the risk-reward ratio is almost optimal.
• Multi-asset funds: A multi-asset fund is a type of diversified mutual fund that invests in different asset classes like equity, debt and money market instruments, among others. This also leads to a wide range of risk levels, return potential and liquidity levels, making such a fund a well-diversified portfolio in itself. Before you choose a multi-asset fund, ensure you check its investment strategy and see if it aligns with your goals.
  

Benefits of investing in Diversified Funds

Diversified mutual funds offer a compelling investment opportunity for investors seeking exposure to a broad spectrum of industries and market capitalisations. These funds provide several key benefits:

1. Comprehensive market exposure: By investing in a diversified fund, investors gain access to a wide range of companies across various sectors and market sizes, mitigating the risks associated with investing in individual stocks.
2. Risk mitigation: Diversification helps to cushion the impact of market volatility. By spreading investments across different sectors and market capitalisations, investors can reduce the potential for significant losses.
3. Long-term wealth accumulation: Diversified equity funds can be a valuable tool for achieving long-term financial goals, such as retirement, education, or major purchases. Consistent investments over time can benefit from the power of compounding, leading to substantial wealth growth.
4. Reduced management effort: Diversified funds are professionally managed, relieving investors of the burden of constant monitoring and rebalancing.
5. Exposure to diverse investment strategies: Diversified funds can employ various investment strategies, such as value investing or growth investing, providing investors with flexibility and the potential to capitalise on different market conditions.
6. Global diversification: Some diversified funds offer exposure to international markets, enabling investors to diversify their portfolios beyond domestic boundaries and potentially mitigate risks associated with local economic fluctuations.

Things to keep in mind before investing in diversified funds

Diversified mutual funds offer a compelling investment opportunity for long-term investors seeking to achieve their financial goals. However, before making an investment, it's crucial to consider the following factors:

1. Investment horizon

• Diversified funds are well-suited for investors with a long-term perspective, as they may experience short-term volatility.
• A minimum investment horizon of five years is generally recommended to allow for the potential realization of long-term returns.

2. Investment objectives

• Diversified funds can be used to support various financial objectives, such as retirement planning, child's education, or a down payment on a home.
• Their diversified investment strategy aims to provide consistent returns over the long term.

3. Expense ratio

• While diversified funds may have slightly higher expense ratios due to their active management and frequent trading, they often outperform many other fund categories.
• It's essential to compare the expense ratio to the fund's performance to assess its overall value proposition.

4. Fund objective and strategy

• Diversified funds seek to generate returns by investing across various sectors and market capitalizations.
• The fund manager conducts thorough research to identify promising investment opportunities based on factors such as earnings per share (EPS), price-to-earnings (PE) ratio, and other relevant metrics.

5. Past performance

• While past performance is not a guarantee of future results, it can provide insights into a fund's ability to navigate different market conditions.
• Analysing a fund's historical returns can help investors understand its risk tolerance and potential for long-term growth.

6. Risk factors

• Diversified funds are subject to market risks, but they generally exhibit lower volatility compared to pure mid-cap or small-cap funds.
• Effective asset allocation and risk management by the fund manager are crucial in mitigating potential risks.

7. Additional considerations

• Investors may also want to evaluate a fund's Sharpe ratio, standard deviation, alpha, beta, and Treynor's ratio to assess its risk-adjusted returns.
• For those unfamiliar with these metrics, consulting with a financial advisor can be beneficial.

By carefully considering these factors, investors can make informed decisions about whether diversified mutual funds align with their financial goals and risk tolerance.

Key takeaways

• Portfolio diversification: Diversified funds allocate investments across various asset classes, regions, and sectors, aiming to mitigate systematic risk.
• Risk reduction: By diversifying, investors can potentially reduce the overall volatility of their portfolios while maintaining desired return expectations.
• Investment options: Diversified funds offer a range of options, from passively managed index funds tracking broad market benchmarks to actively managed funds seeking to outperform specific investment strategies.

Conclusion

Now that you know what a diversified fund is, you can assess your financial goals and check if these funds may be suitable for you. If you do decide to add these funds to your portfolio, you can make a lumpsum investment or opt for SIP investments.

Alternatively, you can also diversify your current portfolio with different types of mutual funds. The Bajaj Finserv Mutual Fund Platform, with 1,000+ schemes to choose from, can help you with this. Check out the fund options available, compare the schemes and make an informed choice.

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