Focused funds are equity schemes that follow a concentrated approach and invest in a limited number of stocks. According to the Securities and Exchange Board of India’s (SEBI) guidelines, focused funds can invest in a maximum of 30 stocks. Also, these funds have no restriction on where they can invest – by market capitalisation or sectors. Hence, these funds are like multi cap funds.
Usually, equity mutual funds hold 50-100 stocks. Some focused mutual funds also state their objective to focus on large-cap, mid-cap, or small-cap. While other funds do not specify any such category focus and follow a bottom-up stock selection investment strategy. The objective of focused funds is to deliver high returns by investing in a limited number of quality companies with growth potential.
Since these funds majorly invest in equity stocks, the funds are highly susceptible to market volatility. Therefore, investors with high-risk tolerance levels can consider investing in focused funds. However, it is necessary to have a long term investment horizon to average out the market volatility and generate significant returns.
Focused Funds have to invest at least 65% of their assets in equity and equity-related instruments and construct a portfolio of no more than 30 stocks. These stocks might come from any industry and from any size company. These funds have a focused portfolio because of the limited number of stocks. The fund managers select and invest in a few stocks that they believe have good growth potential. They have complete control over the allocation of funds across market caps and sectors. Focused funds follow the below two strategies to create their portfolio:
Limited Number of Stocks: Mutual funds often have the choice to invest in as many stocks as they wish. Usually, mutual funds invest across 50-100 stocks. However, these funds follow a concentrated approach, where they invest in a maximum of 30 stocks. The fund manager carefully handpicks stocks with good growth potential and aims to create wealth in the long term. Focused funds are more about picking high-quality stocks rather than investing in a large number of stocks.
Exposure to Diverse Stocks: Focused funds have no restrictions with respect to where they can invest. In other words, they can invest across different market caps, sectors, and themes. To elaborate, these funds can invest in large-cap, mid-cap, small-cap stocks that belong to any sector – technology, pharma, ESG or others. This makes them similar to multi-cap funds. However, the difference is that focused funds have a concentrated portfolio (only up to 30 stocks).
Advantages of Investing in Focused Funds
Following are the advantages of investing in focused mutual funds:
Returns: Diversified mutual funds aim to minimize risk and earn significant returns by investing across multiple stocks. However, investing in a large number of stocks can often lower returns in a volatile market, where only a few stocks are able to outperform. While these funds invest only in a few select stocks that the fund manager believes will perform well. Thus, if the fund manager makes the right investments, the returns can be significant.
Diversification: Focused funds have no restrictions with respect to where they can invest. They have the freedom to invest across different market caps, sectors and themes. Furthermore, they can dynamically change their allocations across market caps to adjust to the market movements. Thus, with these funds, you can achieve a good diversification across sectors and market caps and also benefit from portfolio adjustments to the market volatility.
High Growth Potential Stocks: Since focused funds invest only in a maximum of 30 stocks, the fund manager performs thorough research and carefully handpicks the stocks. The in-depth analysis ensures that the portfolio is constructed only with the best stocks with the potential to generate significant returns.
Disadvantages of Investing in Focused Funds
Following is the disadvantage of investing in focused mutual funds:
Risk: Focused funds are equity mutual funds and, therefore, are subject to market risks. Though the scheme is well-diversified, it doesn’t mean the risk is nil. Thus, focused funds are highly susceptible to market movements, and returns are not guaranteed. As a result, one should be mindful of the potential and inherent risks of focused funds.
Who Should Invest in Focused Funds?
Mutual funds’ primary goal is to provide optimal diversification. However, beyond a certain point, diversification loses its utility and may result in lower returns. Focused funds’ entire strategy is to hit the target with the right stocks and generate significant returns. Thus the fund manager has to focus on identifying the right stocks for the portfolio. This method requires the fund manager to develop rigorous processes for selecting stocks for the fund’s portfolio.
Higher rewards are accompanied by higher risk (losses). Too much focus on a few stocks might either reach the bull’s eye or entirely miss the goal. Getting the right stocks for the portfolio is a skill. The focused funds follow a top-down approach to select stocks and strategically invest in the stocks with good growth potential.
Therefore, if you have high-risk tolerance levels, wish to invest in equity schemes, and do not want too many stocks in the portfolio, you can consider investing in focused funds. Furthermore, it is necessary to have a long-term investment tenure. Only in the long term, you will be able to average out the market volatility and generate significant returns.
Things to Remember while Investing in Focused Funds
Following are the things to remember while investing in focused funds:
Investment Goal and Tenure: Focused funds are not for the short term. They are pure equity schemes and therefore are suitable only for the long term. In the short term, they are highly volatile. Thus, focused funds are suitable for long term objectives and goals. Invest in these schemes for your long-term goals such as retirement, child’s education or wedding, etc. Ideally, you should invest in the scheme for at least 5 years. The longer the investment duration, the lower the impact of market volatility on your returns.
Returns: Historical returns do not guarantee future performance. However, they are a good parameter to understand the performance of the fund over time. Focused funds are highly susceptible to market volatility, and it is important to analyse how they have fared during different market conditions. Thus, analysing the fund’s returns is important.
Fund Manager Expertise: The fund manager’s abilities and knowledge are critical to the success of a focused mutual fund investment. To assure strong returns, they must conduct thorough research and use superior screening procedures to select the best-performing companies. You can analyse the other funds managed by the fund manager and their historical performance across different market cycles. This helps in understanding how efficient the fund manager was able to generate returns for investors.
Risk: These funds invest in a limited number of stocks, usually no more than 30. Thus, the fund invests in only a few stocks, and as a result, it takes big positions in each of the stocks. The limited exposure can be risky if the choice of stocks isn’t right. Furthermore, since they are pure equity schemes, market volatility is inevitable. Therefore, consider investing in these funds only if you are comfortable with the risk levels.
Expense Ratio: The expense ratio is the amount the fund house charges for managing the fund and investments. It is important to invest in funds with a low expense ratio since it will have an impact on the total returns. Your returns will be lower when the fund charges a high expense ratio. Thus, always identify funds with a low expense ratio to enjoy maximum returns.
These funds are equity mutual funds, and the capital gains are taxable on the basis of the investment holding period. For investments with a holding period of less than one year, the short-term capital gains (STCG) are taxable at 15%. While, for investments with a holding period of more than one year, the long-term capital gains (LTCG) are taxable at 10%.