Focused funds: all you need to know

The world of mutual fund investment offers a plethora of options, each catering to different investor risk appetites and goals. Among these, focused funds have emerged as an intriguing option, promising potentially higher returns through a concentrated investment approach. This comprehensive blog delves into the intricacies of focused funds, exploring their core characteristics, benefits, potential drawbacks, and considerations for you before you invest in mutual funds.

What are focused funds?

Focused funds, also known as concentrated funds, deviate from the traditional diversification philosophy of most mutual funds. Instead of spreading their investments across a broad spectrum of companies within a particular sector or market capitalisation range, focused funds concentrate their holdings on a select group of stocks, typically ranging from 20 to 30 companies. This concentrated approach aims to achieve potentially superior returns by capitalising on the fund manager's high-conviction investment ideas.

Key characteristics of focused funds

• Limited Diversification: Compared to diversified equity funds, focused funds hold a significantly smaller number of stocks. This concentrated approach magnifies the impact of each individual stock on the fund's overall performance.
• Active Management: Focused funds are actively managed by fund managers with a strong track record of stock selection. The success of the fund hinges heavily on the manager's ability to identify high-potential companies and construct a winning portfolio.
• High Conviction Approach: The limited number of holdings indicates the fund manager's strong belief in the chosen companies' long-term growth prospects.
• Potential for Higher Returns: By concentrating on a select group of stocks with high growth potential, focused funds have the ability to outperform diversified funds, especially in bull markets.

Benefits of investing in focused funds

• Enhanced Performance Potential: The concentrated approach allows focused funds to potentially outperform diversified funds, particularly when the chosen stocks experience significant appreciation.
• Active Management Expertise: Investors benefit from the expertise of experienced fund managers who meticulously research and select companies with high growth potential.
• Lower Operating Costs: With a smaller portfolio, focused funds typically incur lower operating expenses compared to diversified funds with a broader range of holdings.

Potential drawbacks of focused funds

• Higher Risk: The lack of diversification inherent in focused funds exposes the portfolio to higher risk. If even a few of the chosen stocks underperform, it can significantly impact the fund's overall performance.
• Market Volatility: Focused funds are more susceptible to market fluctuations. A downturn in a specific sector or industry can disproportionately affect the fund's value.
• Manager Dependence: The success of a focused fund heavily relies on the skill and experience of the fund manager. Choosing the right fund manager with a proven track record is crucial.

Who should consider focus funds?

Focused funds are suitable for investors with the following characteristics:

• High-Risk Tolerance: Investors comfortable with a higher degree of risk associated with a concentrated portfolio can potentially benefit from focused funds.
• Long-Term Investment Horizon: Focused funds are best suited for investors with a long-term investment horizon (ideally 5 years or more) to ride out market volatility and potentially reap the rewards of the concentrated approach.
• Understanding of Active Management: Investors should understand the active management style of focused funds and be comfortable with the inherent dependence on the fund manager's expertise.

Considerations before investing in focused funds

• Investment Objective: Align your investment with your overall financial goals. Focused funds are suitable for wealth creation with a long-term focus, not short-term gains.
• Fund Manager's Track Record: Research the fund manager's past performance and investment philosophy. Choose a fund manager with a proven track record of successful stock selection in a concentrated portfolio environment.
• Expense Ratio: Compare the expense ratio of the focused fund with similar offerings from other fund houses. A lower expense ratio translates to potentially higher returns for investors in the long run.
• Overall Portfolio Diversification: Even if you invest in focused funds, ensure your overall portfolio maintains a healthy level of diversification across different asset classes to mitigate risk.

Investing in focused funds

Here's a quick guide to investing in focused funds:

1. Research and Compare Funds: Analyse various focused funds offered by different fund houses. Consider factors like the fund manager's track record, expense ratio, and investment philosophy.
2. Choose a Broker/Mutual Fund House: Select a reputable broker or mutual fund house to invest in focused funds.
3. Invest Online or Through Your Broker: Most brokers and mutual fund houses offer online and offline investment options.
4. Monitor Your Investment: Periodically monitor your focused fund investment and stay updated on market conditions and the fund's performance.

Focused funds vs diversified funds: a comparative analysis

Focused funds and diversified funds represent two distinct approaches to mutual fund investments. Understanding their key differences will help you decide which aligns better with your investment goals and risk tolerance.

Diversified funds

• Investment Strategy: Diversified equity funds spread their investments across a wider range of companies, sectors, and market capitalisations. This diversification aims to mitigate risk by reducing the impact of any single stock's performance on the overall fund's value.
• Benefits: Diversification offers lower risk compared to focused funds. Diversified funds are generally considered more suitable for risk-averse investors or those seeking a more balanced portfolio allocation.
• Drawbacks: The broader diversification can potentially limit the upside potential compared to focused funds, especially during bull markets. Diversification also leads to higher operating costs due to the larger portfolio size.

Choosing between focused and diversified funds

Here's a table summarising the key considerations when choosing between focused funds and diversified funds:

Beyond focused and diversified funds

The investment landscape offers other options to consider when you invest in mutual funds alongside focused and diversified funds:

• Index Funds: Passively managed index funds track a specific market index, offering broad diversification and lower expense ratios compared to actively managed funds like focused funds.
• Sector Funds: Sector funds invest in companies within a specific industry sector, offering exposure to a particular segment of the market but with less diversification compared to diversified equity funds.
• Thematic Funds: Thematic funds invest in companies aligned with a specific theme or trend, offering targeted exposure to a particular growth area but with inherent concentration risk.

Conclusion

Focused funds present a compelling option for investors seeking potentially higher returns through a concentrated portfolio approach. However, the higher risk and dependence on the fund manager's expertise necessitate careful consideration. By understanding the key characteristics, benefits, and drawbacks of focused funds, you can make an informed decision on whether they align with your investment goals and risk tolerance. Remember, a well-diversified portfolio that considers your risk profile and investment objectives remains crucial for long-term financial success.