- Date : 16/04/2022
- Read: 5 mins
Focused funds lie between diversified mutual fund schemes and concentrated sectoral/thematic funds. The article discusses what focused funds are, who should invest in them, and their performance.
Mutual fund houses offer various mutual fund schemes. Investors who need a diversified portfolio can choose from active or index funds based on broader market indices such as Nifty 50, Nifty Next 50, Nifty 100, Nifty Midcap 150, Nifty Smallcap 250, and Nifty 500 indices. Investors who need diversification across indices, sectors, or themes but with a limited number of stocks (maximum 30) can opt for focused funds. Investors who need to concentrate on a specific segment can opt for sectoral or thematic funds.
Also Read: What Are Thematic Funds?
This article will discuss what focused funds are, who should invest in them, the taxation angle, performance, and whether they should be a part of an investor's core portfolio.
What are focused mutual funds?
As per SEBI guidelines, a focused mutual fund is an open-ended equity mutual fund that invests in a maximum of 30 stocks. The scheme has to mention the stocks' focus area, i.e., multi-cap, large-cap, mid-cap, small-cap equities, etc. The scheme's minimum equity investment should always be 65% or higher.
A focused fund invests in a limited number of stocks. Hence, it has a concentrated portfolio. It is the opposite of what diversified equity funds do. In terms of risk, focused funds carry a relatively higher risk than diversified equity funds but relatively lower risk than sectoral or thematic mutual funds.
Chart 1: Focused funds risk profile
The case for investment in focused funds
Most diversified equity funds have a portfolio of 50-100 stocks. While diversification is good, its benefit tapers off beyond 20-30 stocks. We cannot reduce the systematic (non-diversifiable) risk. As per the Modern Portfolio Theory (MPT), we can reduce the unsystematic (diversifiable) risk by diversifying into 20-30 stocks. Adding more stocks beyond this doesn't reduce the risk further. This makes a case for investing in focused funds that can invest in up to 30 stocks.
Chart 2: Diversifiable and non-diversifiable risk
The above chart shows that diversification beyond 20-30 stocks doesn't reduce the unsystematic or diversifiable risk any further. While a concentrated portfolio is risky, an over-diversified portfolio also doesn't provide additional benefits. In such cases, focused funds with optimum diversification serve the purpose.
Who should invest in focused funds?
Focused funds are ideal for investors who have an aggressive risk profile. They are well-suited for investors who want neither diversified funds (based on broader market indices) nor concentrated funds (sectoral or thematic funds).
Focused funds provide limited diversification to an investor. They can invest across market capitalisation (large, mid, small-cap stocks) just like a flexi-cap fund. A focused fund is like a concentrated form of a flexi-cap fund with a limitation of 30 stocks.
So, if you are willing to take higher risk and are looking for limited diversification across market capitalisation, you can consider investing in focused funds.
Also Read: Mutual Funds: A Powerful Investment Tool For Single Mothers
Who should not invest in focused funds?
If you are a beginner in the world of mutual funds, you shouldn't invest in focused funds. First, you should invest in mutual fund schemes based on broader indices such as large, mid, small, flexi-cap schemes, etc. Once you are sufficiently invested in these diversified funds, as a next step, you can look at focused funds or sectoral/thematic funds.
So, a focused fund shouldn't be your first investment in mutual funds. Also, if your investment time horizon is less than five years, you shouldn't invest in a focused fund. You should start a systematic investment plan (SIP) to benefit from rupee cost averaging.
Taxation of focused funds
Focused funds have to invest a minimum of 65% of their total assets in equity and equity-related instruments at all times. Hence, from a taxation point of view, focused funds are classified as equity funds and taxed accordingly.
- Short-term capital gains (STCG) tax: If an investor sells their focused fund units within 12 months of purchase, the profits or losses will be classified as short-term capital gains or losses. This is taxed at a flat rate of 15%.
- Long-term capital gains (LTCG) tax: If an investor sells their focused fund units after 12 months of purchase, the profits or losses will be classified as long term capital gains or losses. Every financial year, the first Rs 1 lakh from LTCG is tax-exempt. Any incremental LTCG over Rs 1 lakh is taxed at 10% without indexation.
Performance of focused funds
Let us look at the returns given by the best focused funds.
Important note:
- The above returns are as of 28 March 2022.
- The focused funds have been ranked based on five-year performance
- The returns are for direct plans with the growth option.
- The one-year returns are absolute. The three and five-year returns are CAGR.
The above table shows how the top 5 focused funds have given returns in the range of 15.6% to 18.3% CAGR in the last five years. These are good returns.
Also Read: Different Types Of Funds Available Under Mutual Funds
Conclusion
Usually, a diversified equity mutual fund scheme has a portfolio of 50-100 stocks. But, the fund manager of a focused fund invests in a limited number of stocks (maximum 30). Over the long run, a diversified equity mutual fund has the potential to give better returns with lower volatility than a focused fund. So, you may divide your equity mutual funds portfolio into a core and satellite portfolio.
The core portfolio can constitute 70%-75% of the overall equity portfolio and include diversified equity funds such as large, mid, small, and multi-cap schemes. The satellite portfolio can constitute the remaining 25-30% of the overall equity portfolio and include focused funds, sectoral funds, thematic funds, and any other type of funds.
