Diversification, as you know, is an important aspect of investing that helps mitigate the risk. As a result, most equity mutual funds hold around 50-80 stocks in its portfolio.
But on the flipside, it involves limiting allocation even in high conviction ideas to curb any potential losses when market conditions turn volatile. Therefore, you, the investor, could miss the growth opportunity from a higher allocation to winning ideas.
Focused mutual funds can be a solution to this anomaly. As the name suggests, focused funds have the mandate to follow a focused investment strategy. Such funds focus on investing in a limited number of stocks (maximum 30), where the fund manager has high conviction.
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The concentrated exposure to select stocks that have high growth potential gives this category of funds the ability to clock high growth rate as compared to the broader market.
So if you are looking to benefit from the growth potential of high conviction ideas, consider investing in Focused Funds.
What are Focused Funds?
Focused funds are equity mutual funds that 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, etc.
While most diversified equity funds invest in a sizeable portfolio of stocks for optimal diversification, the performance of a fund over a period of time is usually driven by a few selected stocks that usually form part of the top holdings in the portfolio.
Even when the stocks beyond the top holdings gain, they do not contribute much to the portfolio returns because of their low weightage in the portfolio.
Graph: Placement of focused funds on risk-return spectrum
Note: For illustrative purpose only
(Source: PersonalFN Research)
This gives the fund managers of focused funds the confidence to 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.
However, if for any reason the fund manager’s bets do not pay off as expected, investors may incur heavy losses due to high concentration of the portfolio.
This makes Focused funds a high-risk high-return investment. Therefore, invest 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: Performance scorecard of Focused Mutual Funds
Data as on February 18, 2021
(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.
Overall, focused fund as a category has showcased satisfactory performance across timeframes. Notably, most focused funds are large-cap biased with significant allocation to mid and small-caps that adds to the stability of the portfolio. Despite this, some funds have performed poorly as compared to the category average as well as the benchmark on many instances. This performance record is an indicator that you need to be extremely careful while selecting a Focused Fund for your portfolio.
Best Focused mutual funds to invest in 2021:
Based on our analysis and research at PersonalFN, Axis Focused 25 Fund, SBI Focused Equity Fund, and Principal Focused Multicap Fund are currently the best schemes in the Focused fund category. These funds fare well on quantitative and qualitative parameters and have the potential to show superior growth in the long run.
Some other decent performers are -
Aditya Birla SL Focused Equity Fund
IIFL Focused Equity Fund
Motilal Oswal Focused 25 Fund
Remember do not pick focused funds by:
The important factor while selecting any scheme is to evaluate the consistency of its performance based on quantitative and qualitative parameters.
Here are the parameters to look into while selecting best Focused funds:
Quantitative Parameters:
Analyse if the fund has shown consistency in performance across various market periods (bull and bear market phases) compared to the benchmark and category peers. Since focused funds take concentrated exposure in select stocks/sectors, it can expose investors to high risk if the fund manager’s bet go wrong. Thus it is important to determine the ability of the focused fund to contain the downside risk during tough market conditions.
For this, determine whether the fund has rewarded its investors well for the risk they have taken using risk-reward ratios like Sharpe Ratio, Sortino Ratio, and Standard Deviation over a 3-year period.
Give preference to those funds that stand strong on risk-reward parameters while short listing funds for your portfolio.
Qualitative Parameters
Qualitative parameters are often overlooked though they are a vital aspect in the selection process. It involves determining the quality of the portfolio and the efficiency of fund manager/house.
The fund house should have a significant performance record and must follow robust investment processes with adequate risk management systems in place.
And because a focused fund's performance is directly dependent on the ability of its fund manager to pick high conviction ideas with superior potential, check the qualification and experience of the fund manager and the track record of the other schemes they manage.
Look at the fund's portfolio for how well diversified it is across stocks/sectors. Remember that a concentrated portfolio can expose you, the investor, to higher risk. Ensure that the scheme optimally diversifies its portfolio within its areas of focus viz. multi-cap, large-cap, mid-cap, large and mid-cap, small-cap to help it sail through adverse market conditions and reduce the impact of volatility.
Moreover, keep a tab on the churning rate of the securities in the portfolio because a high churning rate can make the portfolio prone to volatility and negatively impact the overall returns of the scheme. Analyse the portfolio turnover ratio and expense ratio to assess how efficiently the fund controls the churning and limits the expenses.
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 based 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
The outlook for Focused mutual funds in 2021:
Unlike the last couple of years, the market is witnessing a broad-based rally. The equity market across market caps is exhibiting optimism on the expectations of economic recovery coupled with the low interest rate scenario. Further, the steady decline in active COVID-19 cases, and growth measures announced by the government bode well for consumption and corporate earnings growth.
Overall, the equity market outlook seems bright, unless we witness any adverse events in the near future. If the broad-based rally continues, it can become easier for fund managers of focused fund to pick high conviction ideas across market capitalisation range. Thus, investing in worthy focused funds that are quick to identify high conviction stocks can reward you over the long term with superior risk-adjusted returns.
But do note that the strong rebound since the March 2020 lows has made the valuations very expensive and therefore, the chances of an intermediate correction of around 5-10% from the current high levels cannot be ruled out.
Therefore, 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.
Lastly, when you invest in focused funds, prefer the SIP route to mitigate the impact of volatility and benefit from the power of compounding.
PS: If you wish to select worthy mutual fund schemes, I recommend that you subscribe to PersonalFN's unbiased premium research service, FundSelect.
Additionally, as a bonus, you get access to PersonalFN's popular Debt mutual fund research service, DebtSelect.
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Warm Regards,
Divya Grover
Research Analyst
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