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.
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. I tackled this issue in detail in Does past performance matter?
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. Performance must always be viewed in context of the fund’s portfolio. The latter is the cumulative outcome of the fund manager’s strategy, outlook and the calls made. Does he follow a value strategy, a growth one, or a blend of both? Does he favour concentrated bets or a hugely diversified portfolio? Does he like churning his portfolio rapidly or is a buy-and-hold investor? Is his style more of a perennial bull-run winner or is he a bear market bellwether?
Now let us assume that you have narrowed down on the fund of your choice based on the fund manager’s strategy and historical returns.
That brings you to the next issue-- which stocks you should replicate in your 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. His bets in infrastructure and power corner a lower portion of the portfolio. That does not mean the companies in this sector are to be avoided. It just means he has to protect himself from what he believes is going to happen in the near future. Meanwhile, you would be missing out on such companies and would be straddled with a portfolio packed with healthcare, banking and consumer discretionary stocks. Not only is this unwise, but what happens if his call is wrong?
If you are thinking of mimicking the entire portfolio, that would translate into a personal stock portfolio of at least 50 stocks. That is an awful lot!
Also, in what percentages will you 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. All this churning will result in high brokerage costs and short-term capital gains, currently at 15%. Not to mention what a nuisance it will be when you have to file your returns. In addition, you will have to monitor the portfolio on a monthly basis and make the necessary changes. All this defeats the purpose of investing being made convenient via mutual funds.
You are probably aware that fund houses are not expected to 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.
Incidentally, this is a problem you will face at the very start. When you are piggybacking on a fund manager’s portfolio, you have no idea as to the price he paid for a particular stock. He might have entered the stock when it was at a huge discount to its fair value and by holding on he is repeating the benefits. You may be buying it at a time when it is at a huge premium to its fair value. Not wise at all.
Mutual funds benefit from economies of scale when trading and end up paying a brokerage of just a few basis points. You, as a retail investor, will not be that fortunate. Worth noting is that when a fund buys and sells stocks within 12 months, short-term capital gains tax is not levied. Again, this does not extend to you.
So to answer your question, I do not think it is a viable option to duplicate the portfolio of a fund manager. 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.