How much real diversification do 4 large-cap funds actually provide vs 1 Nifty 500 + 1 mid-cap?
Scenario
Compare a portfolio of 4 actively-managed large-cap funds vs a portfolio of 1 Nifty 500 index fund + 1 Nifty Midcap 150 index fund. Same total capital ₹10 lakh equally split.
Inputs
- Option a
- 4 large-cap active funds
- Option b
- 1 Nifty 500 + 1 Nifty Midcap 150 (index)
- Portfolio size INR
- 10,00,000
Calculation
- 1.
Option A: 4 large-cap active funds — average stock overlap
empirical → 70%
- 2.
Option A: Effective independent funds
1 / (1 + correlation × (n-1)) → 1.5funds
- 3.
Option A: Blended TER (4 × 1.0%)
weighted average → 1%
- 4.
Option B: Nifty 500 + Nifty Midcap 150 — overlap
empirical → 18%
- 5.
Option B: Effective independent funds
1 / (1 + correlation × (n-1)) → 1.8funds
- 6.
Option B: Blended TER (2 × 0.25%)
weighted average → 0.25%
Conclusion
Option B (2 index funds) provides MORE real diversification than Option A (4 active funds) — effective fund count 1.8 vs 1.5 — at a quarter of the TER. Over 25 years, the 0.75 percentage-point TER gap compounds to roughly 18-22% lower terminal wealth in Option A.
Tradeoffs
Option A might marginally outperform Option B in any specific 5-year window if one of the active managers gets a hot run. But SPIVA India data shows this happens to fewer than 25% of large-cap funds over 10-year windows — i.e., the expected value of Option A is below Option B even ignoring TER.