3 Focused Funds That Have Lost Their Focus

As per SEBI's categorization rules, a Focused Fund is a type of open-ended diversified equity scheme investing in a maximum of 30 stocks and at least 65% of its equity portfolio in equity and equity-related instruments.

Moreover, a Focused Fund has to specify the market capitalization it would focus on, i.e. large-cap, mid-cap, small-cap, multi-cap, amongst others. On the risk-return spectrum, a Focused Fund usually is placed below mid and small-cap funds. Having said that, given its conviction-oriented approach with up to 30 stocks, the risk involved could be high.

Not all focused funds have rewarded you, investors with attractive returns. The difference in the returns generated by the top performer and the bottom performer of the category suggests the role the fund manager's conviction plays.

When the equity markets go through a challenging phase, and only a few select stocks drive markets -- just as the way it did between January 2018 and March 2020 -- the high conviction bets of the fund manager may payoff. However, when the market breadth is by and large weak, the portfolio with ample diversification giving better market representation tends to underperform.

Currently, out of 26 focused funds on offer, only 17 have completed 3 years. This means, nearly one-third of the Focused Funds were launched in the past 2-3 years, highlighting the opportunistic nature of some players in the mutual fund industry.

Even those Focused Funds with a longer track record haven't delivered. On the contrary, they routinely underperformed the category average and the broader markets across timeframes, thus finding their place in the list of bottom performers.

Now let's see what led to their underperformance...

Fund #1: JM Core 11 Fund

This scheme was launched in March 2008, i.e. towards the end of the previous multi-year bull market of 2003-08. The fund aims to provide long-term growth by investing predominantly in a concentrated portfolio of equity & equity-related instruments. As per the stated investment strategy of the fund, it invests in a concentrated portfolio of not more than 11 stocks.

The performance of JM Core 11 Fund has been nothing to vie for over longer time frames. It has exposed its investors to remarkably high risk and rewarded investors poorly on risk-adjusted returns. The high-conviction bets taken by the fund haven't paid off very well, and there has been inconsistency in clocking returns.

At PersonalFN, we believe that a Focused Fund with a very concentrated portfolio of 10-12 stocks does not provide adequate diversification across sectors and market capitalisations, and makes it highly risky.

For instance, 4 out of 11 stocks held by JM Core 11 were from the banking and financial sector, carrying a total weight of 34.7% in the portfolio as of February 2022.

The fund's top-5 holdings of JM Core 11 Fund are Maruti Suzuki India, followed by Infosys Ltd., ICICI Bank Ltd., Reliance Industries Ltd., and Larsen & Toubro Ltd., comprising over 50% of the equity portfolio. Due to the large-cap orientation of its top-5 holdings, the fund has missed massive rallies in the midcap IT space and other companies.

Fund #2: DSP Focused Fund

The primary investment objective of the DSP Focused Fund (incepted in June 2010) is to generate long-term capital growth from a portfolio of equity and equity-related securities, including equity derivatives with a maximum of up to 30 companies. The fund invests in companies across capitalisations (multi-caps) with at least 65% in equity & equity-related instruments.

As per its portfolio, as of February 28, 2022, DSP Focused Fund has held 96.9% of its total assets in domestic equities and the remaining 3.1% in cash & cash equivalents. Its current equity portfolio comprises 27 stocks, of which the top-10 accounted for 64.9% of the portfolio.

The equity portfolio of DSP Focus Fund is as allocated as 61% to large-caps and 39% to mid-caps. Despite the thrust of the fund manager on identifying companies from amongst the sectors wherein the opportunity size is fairly large, and the multi-cap strategy followed; the fund has failed to maintain consistency and has trailed many of its peers when compared on all parameters. DSP Focus Fund has exposed investors to noticeably high risk but rewarded poorly on risk-adjusted returns. This places the fund amongst the bottom performers in the Focused Fund sub-category.

Fund #3: Motilal Oswal Focused 25 Fund

Launched in January 2013, Motilal Oswal Focused 25 Fund aims to achieve long-term capital appreciation by investing in up to 25 companies with long-term sustainable competitive advantage and growth potential.

The fund seeks to invest in companies with strong competitive positions, good industry prospects, good business prospects, and quality management that may help achieve the investment objective.

Motilal Oswal Focused 25 Fund also invests up to 35% of its total assets in other than the top 100 listed companies by full market capitalisations but limits itself to the overall limit of 25 companies. The fund follows the buy-and-hold strategy and bottom-up approach for portfolio construction. Apart from valuation factors, the outlook for the respective companies is also the key driver for portfolio churn. In other words, the fund may continue to tolerate high valuations if it sees the company's growth triggers are intact.

As per the portfolio disclosed as of February 2022, the top-10 holdings of the fund accounted for 69.9% of its 23-stock portfolio. The fund has been slashing its exposure to IT and banking & financial services over the last few months. It is noteworthy that during the Foreign Portfolio Investors (FPI)-led sell-off since October 2021, banking and new-age tech stocks have grossly underperformed.

The fund's overweight position in financials and services has weighed down on its performance. The fund has exposed its investors to exceptionally high risk, fared almost on par with peers on risk-adjusted returns but has failed to maintain consistency and trailed its better-performing peers.

Outlook for Focused Funds

The return potential of Focused Funds is closely linked with the underlying portfolio, the fund manager's conviction, and the ideologies of the fund house -- which includes the style of investing, i.e. growth or value -- also affect the performance of Focused Funds.

Given the jittery market conditions against the backdrop of the Ukraine-Russia war, spiralling inflation, and rising interest rates; the corporate earnings of companies may have an impact. If only a handful of companies manage to grow while the majority underperform, Focused Funds that have exposure to such companies could take a hit. Contrary to that, if broader market rallies continue to drive the indices higher, Focused Funds may benefit.

You see, diversification and concentration are two opposite investment approaches. While the former reduces risk and optimises return, the latter increases the risk alongside the chance of potential returns.

Bear in mind, a Focused Fund due to a concentrated portfolio will expose you to higher risk. Hence, only if you have a higher risk profile and investment and an investment time horizon of at least 5 years, you may consider a Focused Fund.

When you are adding a Focused Fund to your mutual fund portfolio, do not commit the following mistakes:

• Give importance to the short-term market outlook

• Depend extensively on the past track record of a scheme

• Not evaluating the risk involved objectively

• Rely blindly on star-ratings

• Rely on friends and relatives who may be unqualified to give you prudent advice on mutual funds

• Disregarding qualitative aspects associated with mutual fund selection

• Ignore your personalised asset allocation

As you have seen how wide the gap is between the top-performing and bottom-performing Focused Funds is (refer to Table 1), careful selection matters! Only then you would be able to generate alpha returns.

Redeeming the underperforming focused funds and replacing them with suitable alternatives should be the desired action at this juncture.

The important factor while selecting any alternative scheme is to evaluate the consistency of its performance based on quantitative (viz. returns across time frame, returns across market cycles, risk ratios, the expense ratio, portfolio turnover, etc.) and qualitative parameters (viz. portfolio characteristics, the credential of the fund management team, among other aspects).

Happy Investing!

Warm Regards,
Rounaq Neroy
Editor, Daily Wealth Letter

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