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Focused equity funds offer higher returns than diversified funds

Focused equity funds offer higher returns than diversified funds

As asset management companies launch funds that invest in just a few stocks, Money Today looks into the merits and demerits of investing in focused funds.

Does a sharp focus help fund managers generate better returns? As asset management companies, or AMCs, launch funds that invest in just a few stocks, the recent being Motilal Oswal's MOST Focused Midcap 30 and Birla Sun Life's Focused Equity Ser 1, we look into the merits and demerits of investing in focused funds.

THROWING LIGHT

Focused funds do not spread assets over a large number of companies. Globally, they are also called "best idea funds," as they choose 20-30 companies (maybe less) according to their mandate. The aim is to deliver high returns by investing in a limited number of companies.

In India, focused funds usually hold 20-35 stocks. As against this, diversified equity funds held an average of 42 stocks in February 2014. Among focused funds, Sahara Super 20 had the least number of companies (21) in its portfolio while Kotak Select Focus had the highest (47).

The number differs according to the fund's mandate. So, Kotak Select Focus and Sundaram Select Focus concentrate on a few themes. There is no limit on the number of stocks Kotak Select can hold while Sundaram Select Focus can hold up to 50 stocks (increased from 30 in September 2010), which is quite high compared to other focused funds.

WHY FOCUSED FUNDS?

Manish Gunwani, senior fund manager, ICICI Prudential Mutual Fund, says the aim is to provide optimal diversification as beyond a point diversification may not contribute to returns. It may, in fact, lower returns. "Limiting the number of stocks in the portfolio ensures that all holdings are of material size. It also forces the fund manager buy stocks about which he is fully convinced," he says. Rather than spreading time and effort over a large number of companies, the fund manager picks up select stocks after extensive research. As there is less room for trial and error, he has to be doubly sure while adding a stock to the portfolio.

"A focused approach ensures that stringent filters are applied to choose stocks as each stock will contribute significantly to the fund's overall performance," says Taher Badshah, senior vice president & co-head, equities, Motilal Oswal AMC.

At the same time, a few wrong choices can hut the fund badly. "If the market becomes polarised and if one is on wrong side of the market, a focused approach can hurt performance," says J Venkatesan, fund manager, equity, Sundaram Mutual.

This is what resulted in the poor performance of Sundaram Select Focus fund (a top performer till 2007) after 2008, says Venkatesan. "After the 2008 crash, the market went into a bearish phase. It also became polarised. A couple of our sectoral calls did not work". The fund later increased the number of stocks it could hold from 30 to 50.

Kotak 50 also increased the number from 30 to 50 in January 2011. After 2008, Kotak 50, too, has not been able to make a comeback. The other funds, except a few, haven't fared any better.

If we compare the performance of these funds, only four have been able to beat or match the Sensex's 14.81% return over a three-year period ended 13 March 2014. These are ICICI Prudential Focused Bluechip Equity, Kotak Select Focus, Reliance Focused Large-Cap and Sahara Super 20.

Srikanth Meenakshi, founder & director, FundsIndia, says, "Focused is just a nomenclature. These are diversified funds which limit their portfolio to a few stocks but not to any particular sector or theme. These funds target investors who want to invest in a few good companies, don't want much churn and stick to the fund for the long term".

So, these funds are more risky than those with a larger number of stocks but also have the potential to deliver better returns if their bets play out well.