Should you copy a Fund’s portfolio?

Instead of investing in an equity fund, would it be easier to copy the portfolio of a successful fund?

Cloning the portfolio of an existing fund appears to be deceptively simple. But there are plenty of nuances that put a spoke in the wheel.

However, let’s look at it for the sake of argument. Mind you, I am not saying it is a good strategy. I am just suggesting that we look into it from various angles.

Q1) Which fund will you select?

The first step is figuring out which fund to hone in on. Most probably, you would start with performance. Are you only going to view the last year’s topper? That will not be a smart move because the fund you select may find itself at the bottom of the heap next year.

Every investor has his own opinion on how to employ performance data. And it is a matter of personal preference. Trailing-return data is easier to understand and takes a lot less time to research than a fund manager’s strategy and process, but don’t make the mistake of looking at past performance alone when making investing decisions.

When looking at performance, please do not view it in isolation. Though past returns play a confirmatory role in any fund selection process, it is not a divining rod. It is just one input amongst many.

Secondly, performance must always be viewed in context of the fund’s portfolio. Which brings us to the next question. It is the cumulative outcome of the fund manager’s strategy, outlook and the calls made.

Q2) Which strategy will you go for?

All diversified equity funds are not the same. There are value strategies, growth strategies and a blend of both. Some fund managers may prefer concentrated stock bets and shun a hugely diversified portfolio. Others may prefer many stocks within sector concentration. One may like to churn his portfolio rapidly, another may prefer a buy-and-hold strategy. One may have an aggressive bull market strategy only to collapse during bear runs, another may win by not losing too much in a bear market.

Now let’s assume you crossed the earlier two barriers and have selected a fund that you believe is right for you, based on the fund manager’s strategy and historical returns.

Q3) Which stocks will you go for?

You certainly are not going to buy all the 40+ stocks in a portfolio. If you choose to go with only the top holdings, you could end up with a dangerously skewed portfolio.

The fund manager may be going with just healthcare, banking and consumer discretionary stocks as his top holdings because he fears a downturn round the bend. Based on his view of the near future, which could be completely wrong, he is protecting himself. Or, conversely, he may decide to bet heavily on infrastructure and power while the above sectors corner a lower portion of the portfolio.

So while he has exposure to all these sectors, if you are going with the top bets, you will not.  You would be missing out on such companies and would be straddled with a portfolio packed with a few select sectors. Very unwise.

And to reiterate the earlier point, what if his call is wrong?

Q4) Have you considered the trading costs?

If you decide to mimic the entire portfolio or a part of it, you will have to decide in what percentages to hold them. Identical to the portfolio? If that be the case, you will have to check what he has bought and sold during the month and make the changes accordingly.

Fund houses don’t declare their portfolios on a real time basis, but once a month. By the time of the disclosure, you would have missed out on the exact price which the stock was purchased or offloaded.

All this is extremely time consuming. Moreover, all this churning will result in high brokerage costs and short-term capital gains. Imagine the nuisance when you have to file your returns. All this defeats the very purpose of investing made convenient via mutual funds.

Piggybacking on a fund manager’s portfolio sounds doable, but is far from a convenient and viable option. The fact that you are mimicking his portfolio goes to indicate that you are convinced these are well-researched stocks. A better option would be to pay the 2-3% expense fee and avoid all the stress of constant monitoring and rapid churning, as well as the additional expenses with regards to brokerage and capital gains.

If you invest in a couple of funds with different investment mandates from various asset management companies, you would have a well diversified portfolio of your own.