When evaluating mutual funds, the primary focus for many individuals tends to be on the returns they offer. While some seasoned investors may delve deeper into additional parameters like rolling returns, volatility, and others, there's one aspect often overlooked – the composition of stocks within a fund's portfolio.
In theory, an excessive number of stocks held within a fund could potentially result in underperformance. However, does this hypothesis hold true in the real-world scenario of investing? Do mutual funds with fewer stocks outperform those with a larger number of stocks? And if they do, should investors consider this factor when selecting mutual funds? Below, we will delve into these questions to uncover insights.
How did we select the mutual fund categories?
Here are four key points to consider:
- We conducted an analysis across four fund categories: large-cap, mid-cap, small-cap, and flexi-cap.
- Our analysis focused on examining the number of stocks held in each fund's portfolio and their performance over the past six years.
- Based on our findings, we categorized the funds into four buckets:
- The first bucket comprises funds with 50 stocks or fewer.
- The second bucket includes schemes with between 51 and 75 stocks.
- The third bucket consists of funds with 76 to 100 stocks.
- Lastly, the fourth bucket encompasses schemes holding over 100 stocks.
- Additionally, we compared the funds' returns against relevant benchmarks to provide a comprehensive overview of their performance.
Now, let's delve into our findings to gain further insights.
How many stocks do top-performing large cap funds have?
Initially, our focus was on large-cap mutual funds. Below is a table illustrating the distribution of schemes across different buckets. For instance, during the past six years, 8 schemes maintained portfolios containing fewer than 50 stocks.
To categorize funds into these buckets, we examined the number of stocks held in each scheme's portfolio over the preceding six years. Subsequently, we utilized their respective medians to allocate them to one of the buckets.
Following the allocation of funds into their respective buckets, we observed that funds with up to 50 stocks outperformed those with 50-75 stocks. Specifically, schemes comprising up to 50 stocks achieved an average rolling return of 13.51%, while those with over 50 stocks attained 13.05%. Consequently, the disparity amounted to approximately half a percent, which, though noteworthy, wasn't substantial. It's also worth noting that no schemes exceeded 75 stocks in their portfolios.
How many stocks do top-performing mid-cap funds have?
Mid-cap mutual funds holding up to 50 stocks outperformed others in this category. They achieved an average 3-year rolling return of 17.39%. In contrast, funds with 50-75 stocks posted an average rolling return of 16.69%. Returns were even lower for funds holding 75-100 stocks in their portfolio.
How many stocks do top-performing small-cap funds have?
In the small-cap mutual funds category, most funds hold between 50-75 stocks in their portfolio. However, even here, funds with up to 50 stocks have shown the strongest performance.
Those with up to 50 stocks recorded an average rolling return of 26.14%, whereas funds with 50-75 stocks achieved 22.22%.
Performance further declined with an increase in the number of stocks in the portfolio.
Only two funds held portfolios with 75 to 100 stocks, while just one fund, Nippon India Small Cap, exceeded 100 stocks.
Now, let's examine the last category - Flexi Cap funds.
How many stocks do top-performing flexi-cap funds have?
The performance of flexi-cap schemes is depicted in the table below, continuing the observed trend. Flexi-cap funds with up to 50 stocks exhibited higher average rolling returns compared to those with a larger number of stocks.
In summary, after examining these four categories collectively, an intriguing pattern emerges:
Funds with up to 50 stocks outperformed those with a higher number of stocks.
As the number of stocks in a portfolio increases, the performance tends to decrease. However, the question remains: why does this phenomenon occur? And more importantly, should investors intentionally favor funds with up to 50 stocks while avoiding those with a greater number?
Are Mutual Funds with a lower number of stocks better?
This study suggests that mutual funds with a lower number of stocks tend to perform better. One possible explanation for this phenomenon could be the risk of underperformance associated with over-diversification. As the number of stocks in a portfolio increases, it becomes increasingly challenging for a significant portion of them to deliver strong returns, leading to diluted overall performance.
However, it's essential to recognize that relying solely on this parameter for mutual fund selection may not be prudent. Investors should establish a comprehensive framework for selecting funds, considering various factors including this one.
Moreover, despite the general trend, there are instances where funds with a higher number of stocks have demonstrated strong performance. For example, Nippon India Small Cap Fund, which held over 190 stocks by the end of October 2023, emerged as the top-performing small-cap scheme. Similarly, HDFC Large and Mid Cap Fund, with approximately 170 stocks in its portfolio, also delivered robust returns.
Therefore, investors need not be overly concerned if their fund increases the number of stocks in its portfolio. Instead, it's crucial to understand the rationale behind this change. For instance, as a fund gains popularity and its assets under management (AUM) expand, the fund manager may need to diversify holdings to effectively deploy these assets.
Increasing the number of stocks as the fund grows is a natural progression observed in all schemes. In such cases, it's advisable to monitor the fund's performance closely. If the fund consistently underperforms its peers, investors may consider reallocating their investments to more promising alternatives.
FAQ
1. Do funds with fewer stocks tend to outperform those with a larger number of stocks?
In many cases, yes. Funds with a lower number of stocks in their portfolios often outperform those with a larger number of stocks. This trend is attributed to several factors, including better concentration of investments in high-performing stocks and reduced dilution of returns.
2. What are some potential reasons for the outperformance of funds with a lower number of stocks?
One possible reason is that a concentrated portfolio allows fund managers to focus on their best investment ideas, leading to higher-quality stock selection. Additionally, maintaining a smaller number of stocks reduces the likelihood of over-diversification, which can dilute returns.
3. Are there any drawbacks to investing in funds with a lower number of stocks?
While funds with fewer stocks may offer the potential for higher returns, they also tend to be riskier due to the lack of diversification. A concentrated portfolio is more susceptible to the performance of individual stocks, increasing the volatility and potential downside risk of the fund.
4. How can investors determine if a fund's performance is influenced by the number of stocks in its portfolio?
Investors can analyze a fund's historical performance relative to its benchmark index and peer funds with different levels of stock concentration. By comparing returns over various time periods, investors can assess whether the fund's performance aligns with the expected outcomes based on its portfolio composition.
5. Should investors prioritize funds with a lower number of stocks when building their investment portfolios?
While the number of stocks in a fund's portfolio is an important factor to consider, it should not be the sole determinant of investment decisions. Investors should assess a fund's overall investment strategy, risk profile, historical performance, and other factors before making investment choices. A diversified portfolio that includes a mix of funds with different levels of stock concentration may offer the best balance of risk and return.
