THE EQUITY MARKETS worldwide witnessed a tumultuous period a year ago. However, their comeback has been equally fascinating. The Indian equity markets have almost doubled between March 2020 and March 2021. In such a situation, the feeling to be part of the the journey is natural for those who have not yet invested in the markets in one form or the other. For those who are already invested, finding a good investment vehicle that gives a good mix of diversification and return is a struggle. If you fall in any of the two categories mentioned above, it is time for you to consider focused equity funds.
What is a focused fund category?
As per the mutual fund categorisation defined by the Securities and Exchange Board of India (SEBI), a focused fund is a special category of equity mutual funds that focusses on a relatively small number of stocks. While there is no restriction on choosing the stocks, the scheme is only allowed to invest in a maximum of 30 stocks.
This fund is different in a few ways. As highlighted above, it invests only in up to 30 stocks, while most other open-ended equity mutual funds do not have such a restriction. You can also consider these funds to be somewhere between a diversified equity scheme and a thematic or sectoral equity scheme. This makes it a combination of a concentrated portfolio that has the right amount of diversification.
Success factors for a focused fund
To be sure, achieving the right balance between diversification and concentration is the trickiest part. And that is where the skill and finesse of an experienced fund manager comes in. A highly-skilled fund manager can choose the 30 companies from across the board without any restriction of market capitalisation or sectors. This effectively could mean choosing the best companies even if they may or may not be the most popular ones. In other words, the decision taken will be a high impact one.
While this might sound easy in theory, bringing this into practice is the real test of the acumen of the fund managers. It demonstrates the processes that they follow and the research that they do while selecting the companies. Moreover, in a volatile market, the process of choosing the best companies is an ongoing process where one sector replaces the other or one company replaces the other at the pole position.
Who should invest in focused funds?
Investing always comes with some risks, which is also true for focused funds. Due to the relatively concentrated nature of the investment basket, the risk is slightly on the higher side. Investors willing to take some degree of risks can definitely consider investing in these funds.
The stock selection criteria applied here would play a crucial role in decision making. Hence, ensure that the fund you are choosing to invest in has well-defined strategies and processes in place. This is crucial as only 30 stocks need to be selected and the right selection determines the returns.
For instance, the ICICI Prudential Focused Equity Fund checks the right boxes. The fund house has a clear process of shortlisting companies. The criterion is not just limited to market leadership, but also takes in to account factors like valuation of a particular stock, future potential and processes of the company that determine its cost structures. This has worked well for the fund thus far. This can be gauged from the fact the ICICI Prudential Focused Equity Fund has been one of the most consistent performers in its category. As of March 31, 2021, the fund has delivered 76 per cent on one-year basis and a solid 13.4 per cent and 14.3 per cent on three- and five-year basis.
To conclude, if you are an investor who is ready to stay invested for at least three years, then focused category of funds is a good bet.
Author is partner at Cerebral Investments & Fiduciary Services.