The cornerstone of any equity market is the underlying corporate earnings. It’s widely believed that, in the long-run, earnings growth and equity performance tend to converge. But, with the advent of Coronavirus pandemic, a company’s business model could possibly alter while their expected earnings growth may reset. Consequently, fund manager’s reliance on the bottom-up philosophy may gain precedence over the macro approach. Under the bottom-up approach, a fund manager invests in companies which may perform relatively well irrespective of the macro-economic cycle.
If an investor desires to invest in a mutual fund that takes concentrated bets on companies, selected by bottom-up approach, they should look at investing in Focused Funds, which is a part of the equity mutual fund universe. According to market regulatory guidelines, Focused Funds can invest into a maximum of thirty stocks, from the large, mid and small cap universe. The portfolio share allocation of market capitalization is done on a tactical basis rather than it being a pre-determined ratio. The portfolio of Focused Funds is sector agnostic and provides flexibility to raise overweight position in order to reap maximum benefits.
Tough parameters for the stock selection
The biggest advantage of Focused funds is its stringent criterion on concentrated bets. While the Mutual Funds are diversified allocations, the presence of too many stocks in a portfolio may lead to over diversification resulting in sub-optimal returns. Therefore, concentrated bets on quality companies in a portfolio offers good earnings potential and can generate superior returns. With a tinge of counter-cyclicality involved in stock selection, Focused funds tend to have a lower correlation with the markets and offers less ‘noise’ returns, particularly in the bull market phase. Thus, an investor looking to park his/her funds for more than three years, in companies, primarily driven by earnings growth than the liquidity push, may consider investing in Focused funds.
Focused Funds could minimize under-performance risk due to market polarization
The concentrated investment strategy could have lower risk of underperformance in recent times, when the concentration risk in benchmark indices has increased manifold, thanks to the few index heavyweights driving the index to higher levels creating polarization. As a result, there is a huge divergence between the returns of the top 15 Nifty 50 stocks and the next 35 stocks. The top 15 Nifty stock delivered 42% returns, while the remaining 35 posted negative returns of 20% since 2018. Owing to unique strategy, of a diversified yet concentrated portfolio, Focused funds posted superior returns versus large cap funds. In last five years, Focused funds, on an average delivered a return of 6.57% as compared with large cap of 4.86%. Focused funds have witnessed inflows of Rs 12,487 crore in the last one year, equivalent to total inflow in multi-cap funds and 72% of large cap funds. The total AUM of this category stands at Rs. 48,225 crore at end of June 2020, which is nearly 7% of total equity AUM.
Why ICICI’s Prudential Focused Equity Fund stands out
Among seventeen funds in this category, ICICI Prudential Focused Equity Fund is uniquely positioned as its portfolio stock selection is based on well-laid out stringent norms.
The fund focuses on the stocks of the company which are well-established market leaders with strong network, or strong balance-sheet and low debt, or the companies which are the lowest cost producer in their respective sectors; most importantly they should be available at a reasonable valuation with a high safety margin. The fund has a dynamic portfolio driven by themes which offer superior earnings growth potential. For instance, the fund increased holding in the stocks that are dependent on the rural economy during the onset of the Covid period, because the cash-flow generation capability is likely to be less affected in rural economy when compared to urban economy.
The Fund is currently overweight on sectors such as telecom, metal and mining, power, software and auto ancillaries compared with sector weight of its benchmark S&P 500 total return index. On the other hand, the Fund is underweight on banking and financial segment. The top 10 holding of the fund constitutes 59.2% of the total AUM in the June 2020.
When it comes to fund’s performance, ICICI Prudential Focused Equity Fund has outperformed its benchmark index as well as category average by 11.4% and 10.5% respectively in the last six months, a most volatile phase witnessed by the equity markets. This is also a demonstration of the fact that a well-crafted strategy will be able to find outperformers even in a wobbly market.
Makesh Sivasankar is chief consultant at Samish Financial Services
The opinions expressed in this article are those of the author's and do not purport to reflect the opinions or views of THE WEEK