Over-diversified mutual funds give good returns now: Is it time to opt for it?

economictimes.indiatimes.com:

Nippon India Small Cap fund is nearing a double century. The figure does not represent its return, but the number of stocks in its portfolio. Yet, it is carrying its size with elan.

Overly diversified funds are often viewed with suspicion, perceived as a drag on returns and lacking conviction. But is a bloated mutual fund portfolio necessarily a white elephant? Several equity funds nowadays appear comfortable running fat portfolios with long tails. There are nearly 20 schemes packed with 80 or more bets, compared to just four such schemes two years ago.

Five of these are stuffed with over 100 stocks. Not surprisingly, most of these schemes belong to the small-cap category. Others have a sizeable presence in both mid caps and small caps.

In the small-cap space, extensive diversification is a must due to liquidity constraints and a higher mortality rate among businesses. As the asset size rises, the funds resort to spreading their bets thin to maintain portfolio hygiene.
Kaustubh Belapurkar, Director, Fund Research, Morningstar Investment Adviser India, observes, “The opportunity in small caps has expanded. Besides, fund managers have to keep a finger on the pulse of the underlying liquidity profile.” For a Rs.10,000 crore small-cap fund, taking a 2% individual allocation means buying a Rs.200 crore block of shares of an Rs.8,000 crore market cap firm.

This can get tricky, says Amol Joshi, Founder, PlanRupee Investment Services. Liquidating a position can be challenging too. Often, fund managers build positions gradually, testing the waters for the investing thesis to play out.