Looks like Focused funds are back in focus. According to AMFI data, Focused funds witnessed inflows in each month beginning April 2019. Kotak Mahindra AMCUnion AMC, and Mirae AMC launched a Focused fund respectively in the current calendar year, while Tata Asset Management’s New Fund Offer (NFO) is underway. This takes the number of funds in the Focused fund category to 23.

[Read: Did the Latest NFOs Make Money for its Investors?]

What is a Focused fund?

Focused funds 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. It can invest in maximum 30 stocks as opposed to 50-100 stocks held by most equity schemes. But while most 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 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.

Equity markets have been highly volatile in the last couple of years. This has negatively impacted the performance of mutual funds in various categories. So did the concentrated bets of Focused funds enable them to buck this trend? Let’s find out…

[Read: Do You Hold These Worst-Performing Equity Mutual Fund Schemes In Your Portfolio?]

Table: Performance of Focused funds over a period of time

Scheme name 1-year (%) 3-year (%) 5-year (%)
Axis Focused 25 Fund 19.65 19.77 13.66
SBI Focused Equity Fund 20.40 16.61 12.86
IIFL Focused Equity Fund 29.31 16.07 12.18
JM Core 11 Fund 15.34 16.10 11.38
Motilal Oswal Focused 25 Fund 18.59 14.69 11.13
Quant Focused Fund 8.61 10.59 10.78
Franklin India Focused Equity Fund 13.69 12.49 10.00
DSP Focus Fund 19.85 13.16 9.81
Nippon India Focused Equity Fund 7.79 10.39 9.24
Sundaram Select Focus 17.69 17.73 9.19
Category average 14.24 13.78 9.88
NIFTY 50 – TRI 14.71 15.71 8.42
NIFTY 500 – TRI 10.38 13.71 8.44

Returns above 1-year are compounded annualised
Data as on November 22, 2019
(Source: ACE MF)

The top performers in the 1-year, 3-year, and 5-year period managed to beat the benchmark returns with a noticeable margin, though the margin was lower during the 5-year period. However, poor performance by some of the funds pulled down the average category returns across period.

Most focused funds follow a multi-cap approach with a large cap bias. In the current volatile phase, large caps have managed to grow steadily even as mid and small caps were beaten down. Hence, most focused funds were able to clock impressive returns in the 1-year and 3-year period.

[Read: Multicap Fund v/s Strategic Mutual Fund Portfolio: What Would Work Best in a Market-High?]

One must remember that past returns are not indicative of future performance. Going forward the rally in large caps could be limited as many stocks are trading at high valuations. Besides, there is uncertainty over when the tides will turn in favour of small and midcaps.

As a result of this uncertainty, if 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.

Graph: How are Focused Funds placed on the risk-return spectrum?

Graph: How are Focused Funds placed on the risk-return spectrum?

(Source: PersonalFN Research)

One of the most successful strategies to build a portfolio of diversified equity funds is to follow the `Core & Satellite’ approach to investing. This strategy lets you focus on the stable schemes with a long-term view and at the same time capitalise on short-term opportunities.

[Read: Why It Is The Best Time To Build A Strategic Mutual Fund Portfolio To SIP Into]

The `Core’ part should constitute majority of your portfolio and include funds that can provide stability over a long-term. The `Satellite’ part comprising the rest of the portfolio can include funds that can push up overall gains of the portfolio by taking active calls based on extensive research.

Focused funds can be a part of your `Satellite’ portfolio along with mid-cap fund, large & mid-cap fund, and an aggressive hybrid fund. The `Core’ part can consist of large-cap fund, multi-cap fund, and a value style fund.

To build a strategic portfolio based on this approach, carefully assign weightage to each category and the schemes for the portfolio based on your financial objective, risk appetite, and investment horizon. Thereafter, select worthy schemes in the respective categories by evaluating its performance based on quantitative and qualitative parameters.

Choose the schemes that are managed by experienced and competent fund managers and belong to fund houses that have well-defined investment systems and processes in place. Each fund should have performed consistently well across market phases and cycles in comparison to their respective benchmark and category peers.

If your portfolio is strategically placed, there will be no need to constantly churn the portfolio and you will be well placed to tide over the market highs and lows.

This article first appeared on PersonalFN here.

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