Investing in mutual funds can be overwhelming. Earlier, fewer asset management companies (AMCs) were offering multiple products of the same investment style. With more entrants to the business, similar products are offered by more AMCs.

The upshot? Choosing an active fund continues to be difficult. Here, we discuss the difference between investment style and investment strategy. Being mindful of this difference can help in your fund selection process.

Style vs. strategy

Investment style is based on size — large-cap, mid-cap and small-cap stocks. We have intentionally avoided considering value and growth styles, as the definition can be transient given India is an emerging market. Investment strategy refers to the rules or approach a portfolio manager applies to select stocks from the benchmark to create a portfolio.

Consider two funds listed on the SEBI website awaiting approval for a new fund offering (NFO). One is a momentum fund and the other, an innovations fund, both with NSE 500 TRI Index as the benchmark. Both funds regardless of the names ought to have the same investment style; for style is determined by the benchmark. Although the investment strategy of both funds could differ significantly, your selection of a fund must be based on its investment style. Why?

Overlap in portfolios

Innovation fund and momentum fund have the same investable universe — the NSE 500 Index. So, it is possible their portfolios overlap. A company that is innovating could also see its stock is on an uptrend. That is, one fund may pick a stock for its high earnings potential whereas another may pick the same stock based on its momentum. Therefore, one fund need not have a significantly different portfolio compared with another with the same benchmark but with a different investment strategy.

Conclusion

Suppose you already hold active funds in your goal-based (core) portfolios. Then, check whether NFOs or existing funds you want to invest in have the same style benchmark as the funds you currently hold. If they do, it may not be optimal to invest in the NFOs or the existing funds.

If the benchmark is a thematic or strategy benchmark, then check if the index constituents do not significantly overlap with the benchmark of the funds that you already hold. If they do not, invest only if you believe the fund fits with your investment objective.

Investing in funds simply based on their investment strategy may not be really optimal.

(The author offers training programmes to individuals to manage their personal investments)