Diversification is important when it comes to investing. However, as with any strategy, there exists a tipping point where too much diversification can be detrimental. Over-diversification, characterised by the scattering of capital across numerous investment avenues, presents a challenge for investors.
Live TV
While speaking to CNBC-TV18.com, Nitin Jain, Chairman and Founder of Neo Wealth and Asset Management, discussed several factors that may lead to over-diversification.
"One primary reason is the tendency of investors to seize investment opportunities as they arise, without considering the overall strategic perspective of their portfolio. Advisors may also contribute to this phenomenon by highlighting new and enticing opportunities, leading investors to spread their investments across numerous avenues," he said.
Additionally, marketing efforts by fund managers and platforms further encourage investors to participate in various themes and sectors.
"This ultimately dilutes the portfolio's focus and diminishes the potential for the alpha generation," Jain said.
He further highlighted the need for a strategic approach to portfolio construction.
The correct approach to diversification
According to Jain, the principle of diversification is the need for low correlation between asset classes.
He highlighted the limitation of merely investing in multiple mutual funds without considering their correlation, as they may all perform similarly in periods of both prosperity and downturns.
Asset allocation
For those aiming at wealth creation, he recommended allocating 50% of investments to exchange-traded funds (ETFs) and index funds, providing broad exposure to the stock market.
Within the remaining 50%, Jain suggested allocating 25% to alternative investments such as private equity, private debt, real assets, infrastructure investment trusts (INVITs), or real estate investment trusts (REITs).
The final 25% of the portfolio should be dedicated to fixed income solutions.
Jain recommended bonds ranging from AA to AAA, which can provide a yield of around 9-9.5% at a portfolio level.
Market dynamics
During periods of market volatility or sharp corrections, investors can further adjust their allocations accordingly.
For instance, if the stock market experiences a significant downturn, funds from the bond portfolio can be reallocated to equities, capitalising on potential buying opportunities.
Regarding small- and mid-cap investments, Jain cautioned against current high valuations and advised a cautious approach, recommending profit booking and reallocating some investments into bonds to mitigate risk.
