Know What Your Mutual Funds Hold

Whilst mutual funds can be an easy and cost effective way to create a diversified portfolio, it’s important to truly understand what your funds hold. Otherwise, your asset allocation may inadvertently duplicate your holdings or invest in funds with contradictory management strategies.

Key Takeaways:

  • Asset allocation is an important determinant of your portfolio’s long-term performance
  • Whilst mutual funds are a helpful diversification tool, it is crucial that you understand what your mutual funds hold as well as their management strategy
  • Otherwise, in an effort to diversify your allocation you may end up duplicating and concentrating your holdings as well as investing in funds with conflicting management strategies

Your portfolio’s asset allocation—its mix of equities, fixed interest, cash and other securities—is crucial. It is an important determinant of your portfolio’s long-term performance. Because of this it is essential to know what you are invested in. This may take a bit of research to determine if you invest in mutual funds or exchange-traded funds (ETFs).

If mutual funds make up a significant part of your retirement portfolio, you should very definitely know the kinds of securities your funds hold. Otherwise your asset allocation may not be what you think it is. If it’s an actively managed fund, you will also want to understand its management strategy. If you don’t know what your funds hold and how they are managed, your attempts to diversify and balance your portfolio may well be unsuccessful. In this article, first we’ll examine how to diversify your portfolio and then we’ll consider some potential risks of relying on mutual funds.

How to Diversify Your Portfolio

You have probably heard about the importance of having a diversified portfolio. The adage “don’t put all your eggs in one basket” suggests investors should spread their investments across multiple countries, sectors and other areas of the market to reduce their portfolios’ risk by not being overly exposure to any single area. But diversification can come in many different styles. So, what do we mean when we discuss diversification and how can you achieve it in your retirement portfolio?

Whilst many people think diversification means an asset allocation that includes a mix of asset classes or investment products, we believe investors can also achieve diversification by owning stocks or bonds that may react differently in various market scenarios. If your investment portfolio includes assets that are all in just one area of the market, your portfolio may benefit when that area is performing well. However, no one country, sector or equity style will outperform forever and these categories often trade leadership.

Diversification means understanding you could always be wrong. By owning some assets that will fare better when the broader markets don’t perform as you expected, you may be able to mitigate some portfolio volatility and risk. Many investors believe their portfolios are diversified if their allocation includes several mutual funds or exchange-traded funds (ETFs). But this thinking assumes all mutual funds hold different securities and that holding various funds makes you diversified. This belief can leave you vulnerable should you be wrong, and it exposes you to other potential portfolio management issues.

Mutual funds and ETFs are popular investments and many investors can successfully use them to build a diversified portfolio. Such funds let you gain exposure to different market sectors or asset classes without having to purchase individual, underlying assets. But when you own several mutual funds, you need to understand what those mutual funds hold because they may own similar securities or make conflicting trading decisions whilst you incur the costs of these transactions.

Potential Risks of Using Multiple Mutual Funds

Overlap and Duplication of Assets. Each fund can include hundreds or even thousands of equities or bonds, and owning too many mutual funds can actually leave you over-diversified. Holding multiple funds or ETFs can also mean that you may own the same security in multiple funds. This raises the possibility of over-concentration in certain sectors, styles or specific stocks and defeats the purpose of diversification.

ETF and mutual fund names may tell you their theme or focus of the fund. For instance, small-cap equity funds, large-cap growth funds, bond funds and debt funds focus on particular types of securities. Index funds track particular market indexes.  With other mutual fund schemes, knowing what they hold will require some research. Asset allocation funds and target date funds both fall into this category. Allocation funds also called asset allocation funds, invest in different mixes of assets and different individual equities, even when you have two funds with very similar names. For instance two different balanced funds may hold quite different investments. Further, for actively managed funds the name doesn’t necessarily speak directly to its market outlook or portfolio positioning.

Conflicting Investing Strategies. Actively managed funds each have their unique strategies, even funds within the same organisation. These strategies are rarely apparent from the fund name. One manager, for example, may feel optimistic about a certain company, whilst another may have a negative outlook. In this scenario, one fund manager may be selling that underlying security whilst another fund that you own is buying it. In this case, you would end up paying the trade cost but for effectively no change in your portfolio holdings. Holding multiple funds may mean that you’re incurring excess costs or have a portfolio with no clear investment strategy, which may not be optimal to get you to your long-term goals.

How Fisher Investments UK Can Help

Creating an asset allocation strategy to ensure a diversified portfolio can be complicated. If you’re looking for help planning and managing your portfolio, Fisher Investments UK may be able to help you and your family meet your investment objectives and financial goals. Call Fisher Investments UK today to speak with one of our representatives or download one of our educational investing guides to learn more.

Investing in financial markets involves the risk of loss and there is no guarantee that all or any capital invested will be repaid. Past performance neither guarantees nor reliably indicates future performance. The value of investments and the income from them will fluctuate with world financial markets and international currency exchange rates.