Year 2000: Underlining diversification

Suresh Krishnamurthy

THE year 2000 underlines the importance of diversification of investments by retail investors.

The year itself started disastrously with the announcement of a decline in coupon rates on a host of small savings schemes, which led to a decline in the coupon rates offered by comparative investment options, such as fixed deposits and bonds. The overall declining interest rate situation gave an advantage to investors in mutual fund income schemes then.

However, by mid-year, those who stayed invested in mutual fund income schemes alone had plenty of reasons to worry over the noticeable decline in investment value after May. The volatility in interest rates had adversely affected their investment values since then. Financial institutions proceeded to destroy the peace of investors by calling back some of their bonds. Again, those who had parked funds in the bonds offered by FIs in 1996 and 1997 were made to face the reality of investing at lower rates with the attendant consequences of lower returns for consumption and so on.

Overall, these three episodes highlighted the need for staying diversified. If an investor had parked all his funds in mutual funds at the beginning of the year, then proceeded to shift all his funds to fixed period investments such as fixed deposits and government small savings schemes by the end of April, then he would have reaped rich dividends. In fact, he would have earned returns that investment in stock markets would not have generated. However, such savvy investing involving fine anticipation of interest rate movements has proved elusive even for slick investment managers at various income funds. A normal retail investor would find such fast-paced action difficult to handle.

Ideally, a retail investor should invest all this surplus funds without attempting to gaze into interest rate movements. These investments -- when diversified over a portfolio of floating rate maturity schemes, such as mutual fund income schemes other than serial plans and options, such as fixed deposits, small savings schemes and bonds -- can reduce the adverse impact of any interest rate changes.

The returns may be lower but it would be a much more comfortable portfolio. Perhaps, a slightly higher proportion of funds can be parked in small-savings schemes, since the returns are much higher than comparable options and, at the same time, entail lower risk. Otherwise, diversification needs to be the pillar on which an investor plans his fund allocation.