Such funds have the mandate to invest in the entire universe of stocks. Although by definition, such funds are meant to have a diversified portfolio (spread across industries and companies), the stock selection is entirely the prerogative of the fund manager.
This discretionary power in the hands of the fund manager can work both ways for an equity fund. On the one hand, astute stock-picking by a fund manager can enable the fund to deliver market-beating returns; on the other hand, if the fund manager’s picks languish, the returns will be far lower.
The crux of the matter is that your returns from a diversified fund depend a lot on the fund manager’s capabilities to make the right investment decisions. On your part, watch out for the extent of diversification prescribed and practised by your fund manager. Understand that a portfolio concentrated in a few sectors or companies is a high risk, high return proposition. If you don’t want to take on a high degree of risk, stick to funds that are diversified not just in name but also in appearance.
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