Focused Funds grabbed the investors' attention in 2019.
This category that aims to generate high growth by focusing on a limited number of stocks had the highest return clocked by any scheme among diversified equity schemes during the year. Its category average was also among the best in equity mutual fund due to impressive performance by various schemes during the year.
As a result, the category saw inflows in each month since April 2019 leading to a sharp rise in its assets under management (AUM). The latest AMFI data shows that focused fund inflows rose manifold in the month of December 2019 to Rs 1,837.37 crore from Rs 479.29 crore in the previous month and Rs 227.57 crore in the month of April.
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What are focused funds?
Focused Funds are equity-oriented mutual funds that can invest in maximum 30 stocks. These funds are mandated to invest minimum 65% of its assets in equity and equity related instruments. The fund needs to state where it intends to focus, viz. multi cap, large cap, mid cap, small cap.
Equity mutual funds usually hold a sizeable portfolio of 50-100 stocks. However, the performance of a fund is usually driven by a few selected stocks in the portfolio.
The fact that fund managers allocate low weightage to most stocks beyond top 10 or 20 holdings means that the fund manager lacks conviction in them. Even when these stocks gain, they do not contribute much to the portfolio returns because of their low weightage in the portfolio.
This gives the fund managers of focused funds the confidence to scrap out stocks at the tail of the portfolio and focus on few high conviction stocks with high growth potential. The fund managers usually follow a buy and hold strategy leading to a reduced portfolio churn.
Graph: Placement of focused funds on risk-return spectrum
Note: For illustrative purpose only
(Source: PersonalFN Research)
On the risk-return spectrum, focused funds are placed just a level below mid cap funds, meaning they carry higher risk. The managers of focused funds lay bet on few high conviction stocks having potential to generate superior returns. However, if the fund manager's bets do not pay off as expected, investors may incur heavy losses due to high concentration of the portfolio.
Therefore, invest in focused funds only if you are an aggressive investor with a long investment horizon. If you are a moderate risk taker, invest in diversified equity funds where the focused fund can form a small part of your portfolio.
Table: Focused funds clocked extraordinary returns in the last one year
Returns are point-to-point
Data as on January 24, 2020
(Source: ACE MF)
*Please note, this table only represents the best performing Focused Funds based solely on past returns and is NOT a recommendation. Mutual Fund investments are subject to market risks. Read all scheme related documents carefully. Past performance is not an indicator for future returns. The percentage returns shown are only for an indicative purpose. Speak to your investment advisor for further assistance before investing.
In the last 1 year, focused funds generated a remarkable average category return of 17.4%, outpacing the benchmark with substantial margin. Over the longer time horizon of 3 years and 5 years various schemes managed to outperform the benchmark.
Some of the best focused funds, as per PersonalFN, that fare better on both quantitative and qualitative parameters are SBI Focused Equity Fund and Sundaram Select Focus.
Some other top performers are:
But keep in mind that the past performance is not indicative of future returns. Hence, if you invest in top performing schemes of 2019 anticipating that they will be top performers in 2020, you may be disappointed.
Remember do not pick focused funds by:
The important factor while selecting any scheme is to evaluate its performance based on quantitative and qualitative parameters.
Here are the parameters to look into while selecting best focused funds:
Quantitative Parameters:
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Performance and risk analysis
Analyse if the fund has shown consistency in performance across various market periods with decent risk-adjusted returns.
Under this, you need to rank the fund based on quantitative parameters like rolling returns across short-term and long-term periods, such as a 1-year, 3-year, and 5-year timeframe, and on risk-reward ratios like Sharpe Ratio, Sortino Ratio, and Standard Deviation over a 3-year period.
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Performance across market cycles
You need to ensure that the fund has the ability to perform consistently well across multiple market cycles. Therefore, compare the performance of all the available focused funds vis-a-vis their benchmark index as well as category peers across bull phases and bear market phases.
A fund that performs well on both sides of the market should rank higher on the list.
Qualitative Parameters
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Portfolio Quality
Adequate Diversification - The scheme should not hold a highly concentrated portfolio. It should have a well-diversified portfolio and the exposure to the top-10 holdings should be ideally under 50%.
Low Churn - Engaging in high churning can result in higher cost impacting the overall return of the scheme. Therefore, you also need to consider the portfolio turnover ratio and expenses, and penalise funds involved in high churning, i.e. those funds with a turnover ratio of more than 100%.
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Quality of Fund Management
You must consider the fund manager's experience, workload, and the consistency of the fund house. Therefore, assess the following criteria:
The fund manager's work experience - He/she should have a decent experience in investment research and fund management, ideally over a decade.
The number of schemes managed - A fund manager usually manages multiple schemes. Thus, you need to check if the fund manager is burdened with managing a large number of schemes. If they are managing more than five open-ended funds, it should raise a red flag.
The efficiency of the fund house in managing your money - Research about the fund house's performance across schemes; find out if only a few selected schemes are doing well. A fund house that performs well across the board is an indication of sound investment processes and risk management techniques in place.
Yes, we know that the above list is a lot for an average investor to look at. It involves number crunching and much of the data is not easily available in one place. But if you do need to narrow down on the top funds, these factors are of utmost importance.
Watch this short video on selecting mutual fund schemes:
At PersonalFN, we select and recommend mutual funds on quantitative and qualitative parameters using our S.M.A.R.T Score Matrix:
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S - Systems and Processes
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M - Market Cycle Performance
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A - Asset Management Style
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R - Risk-Reward Ratios
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T - Performance Track Record
Outlook for focused funds in 2020
Focused funds exhibited healthy performance in 2019, but it won't be wise to rely heavily on past performance. Since the market rally during the year was driven by a handful of stocks, fund managers were able to pick such stocks and take concentrated exposure in them. Going forward if there is a broad based rally, other categories of mutual fund may turn out to be top performers.
That said, if you invest in worthy focused funds that are quick to identify such high conviction stocks, it can reward you over the long term with superior risk-adjusted returns. As the economy is expected to recover gradually, investment in equity mutual funds can prove to be an efficient investment avenue. However, one cannot rule out short-term volatility -- equity market and volatility go hand-in-hand.
Before investing ensure that the schemes align with your set investment objective and personalised asset allocation plan. Review your investment at regular intervals to ensure you're on the right track to accomplish your envisioned financial goals.
Editor's Note: If you wish to select worthy mutual fund schemes, I recommend you to subscribe to PersonalFN's unbiased premium research service, FundSelect.
Additionally, as a bonus, you get access to PersonalFN's popular debt mutual fund service, DebtSelect.
Each fund recommended under FundSelect goes through our stringent process, where they are tested on both quantitative as well as qualitative parameters.
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Author: Divya Grover