What are focused funds?

Over the years, Focused funds have gained attention for their distinct approach to portfolio construction. This article explores what focused funds are, their advantages and disadvantages, and discusses the ideal investor profile for these funds.

Table of contents

• Focused funds definition
• Types of focused funds
• Advantages of focused funds
• Disadvantages of focused funds
• Who should invest in focused funds?
• How to Invest in focused funds
• Taxation and regulatory guidelines for focused funds

Focused funds definition

Focused funds belong to the category of equity mutual funds and are characterised by their concentrated portfolio approach. Unlike diversified funds that hold a wide range of stocks across various sectors, focused funds limit their investments to a select number of stocks, typically ranging from 20 to 30, with 30 being the maximum that is permitted. The primary objective is to create a focused portfolio of high-conviction stocks, allowing fund managers to capitalise on the potential of these select companies.

Types of focused funds

While focused funds are not officially categorised into sub-types, SEBI mandates that the fund house must specify what the fund’s investment universe would be. This could include:

• Large cap stocks: Those ranked 1 to 100 on recognised stock exchanges based on market capitalisation. These are typically well-established firms with a track record of relatively stable growth (past performance may or may not be sustained in future).
• Mid cap stocks: These are companies ranked 101 to 250 on recognised stock exchanges. These are companies in their expansion stage, with more long-term growth potential than large caps but with more volatility.
• Small cap stocks: Listed 251 and beyond. Such stocks tend to offer high long-term growth potential but can also be highly volatile, especially in the short term.
• Multi cap: Such funds may invest in all three market caps.

Advantages of focused funds

High conviction stocks: Focused funds invest in a limited number of stocks, typically those that the fund manager has high conviction in. This can lead to a portfolio comprising companies with strong growth potential and solid fundamentals.

Potential for better returns: The concentrated nature of the portfolio allows for a more significant impact on the performance of individual stocks. If the selected stocks perform well, the fund has the potential to generate relatively better returns compared to more diversified funds.

Active management: Focused funds demand active management as fund managers constantly evaluate and adjust the portfolio based on market conditions and the performance of the selected stocks.

Disadvantages of focused funds

High risk: The concentrated nature of focused funds exposes investors to higher risk. If one or more of the selected stocks underperform, it can significantly impact the overall performance of the fund.

Market dependency: Focused funds' success is highly dependent on the fund manager's ability to accurately identify high-performing stocks and the right market opportunities.

Less diversification: The limited number of stocks in the portfolio means less diversification. In the event of poor performance by the selected stocks, there are fewer alternative investments to offset losses.

Who should invest in focused funds?

Experienced investors: Focused funds are suitable for investors with a good understanding of the market and a higher risk tolerance. Due to the concentrated nature of the portfolio, investors need to be comfortable with the potential for higher volatility.

Long-term investors: Investors with a long-term investment horizon may find focused funds appealing. The concentrated approach may take time to yield results, and long-term investors can ride out short-term market fluctuations.

Risk-taking investors: Individuals willing to take on a higher level of risk in pursuit of potentially better returns may consider allocating a portion of their portfolio to focused funds.

How to invest in focused funds

Investors can invest in focused funds in different ways.

• Offline mode: Investors need to fill out an application form and submitting it either to their distributor or directly to their nearest AMC branch or official point of contact.
• Online mode: Investors may also invest through a Demat account or via the AMC’s website, either independently or through a distributor.

Taxation and regulatory guidelines for focused funds

Focused funds are equity funds and are taxed as follows. Short-term capital gains tax rate is 20%, and long-term capital gains above Rs. 1.25 lakh are taxed at 12.5.

As per regulatory guidelines, a focused fund should not invest in more than 30 stocks and must maintain an equity allocation of at least 65% of total assets. Additionally, it should be specified where the scheme intends to focus (namely multi cap, large cap, mid cap or small cap).

Conclusion

Focused funds offer a unique investment strategy that depends on the concentration of high-conviction stocks in a limited portfolio in terms of number of stocks held. While these funds present the potential for higher returns, they come with increased risk and volatility. Therefore, investors should carefully assess their risk tolerance and investment goals before investing in focused funds.

FAQ

What is a focused mutual fund?

A focused fund invests in a limited number of stocks (up to 30), aiming to potentially outperform its benchmark in the long term through a concentrated portfolio.

What is the meaning of focused funds?

Focused funds are mutual funds that invest in a limited number of stocks, up to 30, as mandated by SEBI. By concentrating investments in select companies or sectors, they aim to outperform the broad market over time — but this also increases risk due to reduced diversification.

Are focused funds suitable for short-term investors?

No, equity funds in general are suitable for long-term investors, because market volatility can significantly impact potential returns, especially in the short-term. Focused funds, being higher risk owing to their concentrated nature, also require a longer investment horizon.

What are the risks involved in focused funds?

Apart from market risks that affect all equity investments, focused funds also carry higher concentration risk because of their narrow portfolio composition.

How many stocks do focused funds usually hold?

Typically, focused funds can hold up to 30 stocks to maintain a concentrated strategy.

Can focused funds provide diversification?

Diversification is limited; they may provide some diversification but not as much as other types of mutual funds.

How is investing in focused funds different from diversified funds?

Focused funds concentrate on fewer stocks, whereas diversified funds spread investments across a wider set of sectors and companies to reduce risk.

What is the minimum investment horizon?

Investors may consider a horizon of at 5-7 years for focused funds.

How are focused funds taxed?

STCG is taxed at 20% and LTCG above Rs. 1.25 lakh is taxed at 12.5%.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.