Why more investments don’t necessarily mean better diversification, explains PPFAS Wealth

A portfolio with 10 mutual fund schemes, investments in private credit and exposure to unlisted shares may look diversified on paper. But if several investments carry similar risks, or a large share of the money is difficult to access when needed, the portfolio may be more concentrated and less liquid than it appears.

This is a common gap in how investors approach diversification, according to Khushboo Joshi Parikh, President, PPFAS Wealth.

“There is a notion that greater wealth calls for non-traditional products,” Parikh said, attributing the growing interest in alternatives partly to an increase in product offerings and the appeal of diversification. However, complexity does not necessarily translate into higher returns.

She said the majority of PPFAS Wealth’s clients’ allocations continue to be in mutual funds, while other products are considered when they fulfil a specific portfolio need. The assessment includes the investment structure, quality of management, risk, fees, taxes and other expenses.

Why more funds may not mean better diversification

Holding several schemes does not necessarily reduce concentration risk. For instance, investing in multiple momentum-oriented schemes or several mid- and small-cap funds may leave a portfolio exposed to similar strategies or market movements.

The same applies to investments beyond listed markets. Unlisted equity adds to equity exposure, while private credit introduces credit risk. Both can also limit access to money when required.

Most investors equate risk with volatility. The bigger risks are permanent loss of capital and not having money available when it is needed, and neither shows up in a past-returns table.KHUSHBOO JOSHI PARIKH, PRESIDENT, PPFAS WEALTH

Parikh said investors should define their financial objectives first and then select products that meet those needs, rather than buying investments based on market trends, hearsay or recommendations from others.

Private credit and alternatives: What investors should assess

Private credit, pre-listing infrastructure investment trusts (InvITs) and small and medium real estate investment trusts (SM REITs) are sometimes viewed as alternatives to conventional fixed-income investments. However, their risk and liquidity profiles can differ.

Parikh cautioned against treating these products as straightforward high-yield debt substitutes. Investors should examine the underlying risks, exit conditions and net returns after fees, taxes and other expenses before investing.

“An extra percent of return is rarely worth the credit risk taken to earn it,” she said.

Fixed income, meanwhile, can provide stability and liquidity when investment maturities are aligned with future cash-flow requirements. Parikh said investors should avoid chasing yields without considering when they will need the money.

She also noted that the removal of indexation benefits for specified debt mutual funds has affected their tax treatment. Hybrid funds and REITs may serve particular portfolio needs, but their suitability depends on their underlying characteristics and the investor’s requirements.

Risks that past returns may not reveal

Investors often associate risk with market volatility. Parikh said permanent loss of capital and the inability to access money when needed are also important risks that historical return figures may not capture.

Asset allocation, she said, should reflect an investor’s financial goals, cash flows and suitability. Market corrections can provide opportunities to rebalance, provided the portfolio has sufficient flexibility.

International investments can also contribute to diversification, given the range of global companies and sectors unavailable in Indian markets. Parikh said international allocation has a role in portfolios beyond short-term market performance.

How investment risks differ across generations

Parikh said older investors may underestimate inflation and concentration risk while favouring traditional products such as fixed deposits and insurance. Younger investors who have experienced predominantly rising markets may underestimate illiquidity and the time required for markets to recover from a downturn.

First-generation entrepreneurs face a different consideration: much of their wealth may already be concentrated in their businesses. Their investments outside the business may therefore need to account for the equity risk and limited liquidity they already carry.

What investors should ask before investing

Parikh said investors expect wealth managers to explain the purpose of each allocation, disclose fees and assess whether a product fits their requirements.

Before investing, individuals should consider:

• Purpose: What financial goal does the investment serve?
• Risk: Does it increase existing equity, credit or concentration exposure?
• Liquidity: When can the money be accessed, and under what conditions?
• Net returns: What remains after fees, taxes and other expenses?
• Understanding: Do they understand how the product works and how they could lose money?

Parikh said investors should be willing to pass up opportunities they do not fully understand. The focus, she said, should be on selecting investments that serve defined objectives rather than adding products simply to expand the portfolio.

Ultimately, diversification depends on the underlying exposures, risks and liquidity of investments, not merely the number of schemes or products held.