What is Focused Equity Fund

In Mutual Funds, diversity is often regarded as a risk-mitigating strategy. Diversified Equity Funds typically spread their investments across a wide array of Stocks to reduce the impact of underperformance in any single security. However, there exists another class of Mutual Funds that takes a different approach – Focused Mutual Funds. These, as the name suggests, concentrate their investments in a limited number of carefully selected Stocks. In India, the Securities and Exchange Board of India (SEBI) allows Focused Funds to invest in a maximum of 30 Stocks. This concentrated approach may seem unreasonable at first, but it has its merits and appeals to a specific class of investors.

How do Focused Mutual Funds work?

To comprehend the workings of Focused Mutual Funds, one must delve into where and how these funds allocate their investments.

Limited Number of Stocks:

Unlike traditional Equity Mutual Funds that often hold between 50 to 100 Stocks, Focused Mutual Funds deliberately limit their portfolio to a maximum of 30 Stocks. This concentrated approach signifies a high conviction strategy, where Fund Managers place their bets on a select few Stocks.

No Restrictions on Investment Universe:

Focused Funds enjoy the flexibility to invest across the entire spectrum of the stock market. This means that they can allocate capital to Large-Cap, Mid-Cap and Small-Cap Stocks without any restrictions. These funds resemble Multi-cap Mutual Funds, but with reduced number of Stocks. Fund Managers have the autonomy to determine the allocation among different market capitalisations, adapting to market dynamics.

Advantages of Focused Mutual Funds

High Potential Returns:

The core advantage of Focused Mutual Funds lies in the potential for high returns. While Diversified Equity Funds aim to minimise risk through broad diversification, this approach can sometimes limit returns, particularly in a market where only a handful of Stocks outperform. Focused Funds on the other hand, invest with conviction in select Stocks that the Fund Manager anticipates will outperform, potentially delivering superior returns.

Diversification across Company Sizes:

Focused Funds are not confined to a specific company size. They can invest across Large-Cap, Mid-Cap and Small-Cap Stocks. They can adjust their allocation based on market conditions. This flexibility provides investors with diversified exposure, across different market capitalisations.

Exposure to Handpicked Stocks:

Given the limited number of Stocks in their portfolio (up to 30), Fund Managers of Focused Funds conduct thorough research and analysis to identify the best-of-the-breed Stocks. This meticulous Stock selection process can potentially result in better returns compared to broader market indices.

Diversification across Sectors:

While Focused Funds maintain a concentrated portfolio, they have the freedom to select Stocks from any sector. This ensures the portfolio is not restricted to any sector, reducing the risk associated with a specific industry's performance.

Who should invest in Focused Mutual Funds?

Focused Mutual Funds are not for everyone and they cater to a specific set of investors:

Appetite for Risk:

Focused Funds inherently carry a higher risk due to their concentrated portfolio. A single incorrect bet can lead to significant losses. Therefore, investors considering Focused Funds should have a risk appetite greater than required for Diversified Mutual Funds.

Investing Experience:

If you are new to investing, it may be prudent to begin with Diversified Mutual Funds. Focused Funds can exhibit higher volatility in the short to medium term. Thus, investors with a few years of investment experience may find them more suitable.

Long-term Investment Horizon:

Since Focused Funds take selective bets, these bets may take time to materialise. Investors should have an investment horizon of at least five years, to realise the Fund's full potential.

Things to consider before investing in Focused Mutual Funds

Risk:

The concentration of holdings in Focused Funds (up to 30 Stocks) increases their risk compared to Diversified Mutual Funds. Investors should carefully assess their risk tolerance before investing.

Returns:

Focused Funds can outperform Diversified Funds in broader markets during divided market conditions. However, their returns may lag behind in a more evenly distributed market. Assess your investment goals and market conditions before investing.

Cost:

Pay attention to the expense ratio of Focused Funds, as lower expenses can lead to higher take-home returns.

Investment Horizon:

Given the potential for short-term volatility, consider a longer investment horizon of at least five years when investing in Focused Funds.

Tax Implications on Focused Mutual Funds

Taxation of Focused Funds align with other Equity Funds. Gains held for more than a year are categorised as Long-Term Capital Gains (LTCG) and taxed at 10% if the total gains in a year exceed Rs 1 lakh. Short-Term Capital Gains (STCG) from holding for less than a year, are taxed at 15%.

Top 5 Performing Focused Funds

For investors seeking to explore Focused Mutual Funds, here is a list of the top-performing Funds in the last three and five years:

• ICICI Prudential Focused Equity Fund Direct-Growth: 3-Year Return - 24.85%, 5-Year Return - 18.09%

• Quant Focused Fund Direct-Growth: 3-Year Return - 26.64%, 5-Year Return - 19.00%

• HDFC Focused 30 Fund Direct Plan-Growth: 3-Year Return - 31.00%, 5-Year Return - 18.27%

• Franklin India Focused Equity Fund Direct-Growth: 3-Year Return - 24.99%, 5-Year Return - 17.89%

• Nippon India Focused Equity Fund Direct-Growth: 3-Year Return - 24.58%, 5-Year Return - 17.83%

Focused Funds offer a unique investment proposition for those willing to embrace concentration and higher risk in exchange for the potential of huge returns. However, investors should carefully evaluate their risk tolerance, investment horizon and market conditions before considering these Funds. As with any investment decision, thorough research and understanding of individual financial goals is essential.