Focused funds focus more on selecting best stocks than diversifying into many stocks. If the bets turn out positive, the performance of focused funds can shoot up more sharply than a fully diversified fund

While most fund managers swear by diversification to reduce risk, there are some who believe that holding a tight portfolio is also a good way to make money in the stock markets. Based on similar approach, Axis Asset Management recently launched a new equity scheme called Axis Focused 25 Fund, which mandatorily invests in up to 25 scrips. While the performance of this fund will be checked out in future course, the question that arises here is should someone invest in such funds which by stipulation do not allow to diversify? The funds which have such tight portfolios are termed as ‘focused funds’.

Focused funds are those equity funds which invest in lesser number of stocks. Typically, equity diversified funds invest in as little as about 30 scrips and can go up to 80 stocks, while the funds with focused approach pay full attention into 20 to 25 stocks. Normally, equity diversified funds invests in all kinds of stocks, irrespective of market cap while focused fund mostly remains biased towards large caps. There are five to six mutual fund schemes which work on this focused approach. Let’s know more about these funds and their pros and cons.

Features
The core element of focused funds is more on selecting the best stocks than to diversify into many stocks. The funds try to identify and invest mostly in large cap companies with proven track record, quality management and good growth potential. The assumption being that large caps are relatively safer by way of lower volatility and a better bet in turbulent economic conditions. If the bets turn out positive, the performance of the fund can shoot up more sharply than a fully diversified fund.

History may not be repeated
Focused funds are launched on the strong premise that quality companies tend to maintain their growth trajectory despite downturns. In a study that a fund house conducted to illustrate the merits of holding fewer companies, it was revealed that between December 2003 and December 2011 the top 10 companies within the BSE 100 Index delivered an average return on equity of 37 per cent (compounded annualized) as compared to 26 per cent for the BSE 100 index. However, the share price of these top 10 companies appreciated by as much as 30 per cent as compared to a negative 15.8 per cent for the bottom 10 BSE 100 companies. But then this is a historical data and past performance may or may not be sustained in future.

Investment rationale & concerns
A focused fund has some advantages and some disadvantages. These funds will ensure that the fund manager takes a meaningful exposure in individual scrips as he or she will have more time and energy to study the portfolio and can follow the investments more intensively. It is easier for a fund manager to be familiar with 25 stocks rather than tracking more than 70 or 100 stocks all the time. On the other side, as the fund manages a focused portfolio, risk involved is more than a well diversified equity fund and hence meant for investors who can digest high volatility. If the fund manager gets his calls wrong in the future, it could depress the fund's returns more quickly.

Invest or not to invest
A fact should be noted that whether the scrips in a portfolio, be 10 or 100 it cannot guarantee performance. A fund with small portfolio will carry a decent amount of risk while a fund having too many companies may trouble fund manager to generate a target return. Let’s share an example of JM Core 11 which is the worst performer when it comes to annualized returns (see table). However, in the last six months it has come up with a phenomenal 23 per cent return with almost 12 per cent return in last one month (as on 04/07/12). Seeing past performance one might have not gone for this scheme, but then who timed it well would be enjoying now.

All of the scheme in focused fund category are new and has not spent even 5 years in the market. On the other side, barring ICICI Prudential Focused Blue-chip, no other fund has come up with an attractive return. So a straight advice whether to invest or not would be difficult. Most of the investment advisors advise investors to put their money in a diversified fund as putting all the money in a limited number of scrips are too risky. However, a compelling counter argument is that instead of over diversification a reasonable diversification is enough to achieve results. Hemant Rustagi, CEO, Wiseinvest Advisors, says “One can invest in focused fund but it should be a strategy and not a core investment”. He explains, “If someone wants to invest 40 per cent of his asset in large cap, he may deploy 30 per cent in normal diversified funds and rest 10 per cent in focused funds. Though focused funds are riskier they have potential to perform better than diversified funds.”