In the past few years, mutual funds have grown tremendously. The assets under management have increased fivefold in the last decade, from ₹8.26 lakh crores in June 2013 to ₹41.62 lakh crores in June 2023. Focused equity funds have emerged as an option for investors seeking potentially higher returns by concentrating their investments on a limited number of carefully selected stocks.
Let’s find out. In this article, we will go through meaning, types, and benefits of focused equity funds in the Indian investment landscape.
What is a focused equity fund?
A focused equity fund is a type of fund that aims to generate substantial returns by maintaining a concentrated portfolio of stocks. Unlike diversified funds that hold many securities across various sectors, focused equity funds typically invest in a limited number of high-conviction stocks. The fund manager carefully selects these stocks based on in-depth research and analysis to outperform the broader market.
Now, this seems fairly risky. If you invest in a banking sector focused equity fund, for instance, and the RBI announces further rate hikes, your entire portfolio will be affected. There will be no safety to fall back on or cushion the blow.
Why, then, do people invest in such funds?
Well, you need to remember that risk and return go hand-in-hand. If the RBI announces a supportive policy, for instance, that strengthens the position of banks, then your entire portfolio will boom!
What are the different types of focused equity funds?
1. Sector-specific focused equity funds
These funds focus on a particular sector of the economy, such as banking, technology, or healthcare. They aim to capitalise on the growth potential of a specific industry.
For example, if you expect the banking sector to emerge on a bullish run in the next few years, you can opt for a BFSI-focused fund to capture that growth.
2. Theme-based focused equity funds
These funds concentrate their investments on a specific theme or trend, such as renewable energy, e-commerce, or infrastructure development. Theme-based funds provide an opportunity to capitalise on emerging trends and can be a suitable choice for investors with a long-term perspective.
For example, if you expect renewable energy to catch on in the next few years, you can pick a suitable fund for the same. It will allow you to invest in companies from different sectors that are all focused on application of renewable energy.
3. Multi-cap focused equity funds
Multi-cap focused equity funds invest across market capitalisations, including large-cap, mid-cap, and small-cap stocks. The fund manager identifies several companies across different segments expected to deliver superior performance and builds a concentrated portfolio around them.
What are the benefits of focused equity funds?
1. Potentially higher returns
Due to their concentrated portfolio, these funds can potentially deliver higher returns than diversified funds. By carefully selecting a limited number of high-quality stocks, fund managers aim to capitalise on the best investment opportunities available in the market.
Please note, however, that the higher concentration can also lead to higher risk exposure.
2. Active management
These funds are actively managed, with fund managers regularly monitoring and adjusting the portfolio based on market conditions and research insights.
This active approach allows them to take advantage of market inefficiencies and potentially generate alpha, i.e., returns above the benchmark index.
3. Diversification within concentration
Although focused equity funds have a concentrated portfolio, they still offer diversification within that concentration. By investing in a limited number of carefully selected stocks, focused equity funds provide diversification within the chosen stocks.
The fund manager considers factors such as industry diversification, company size, and growth potential while constructing the portfolio. This diversification helps manage risk and reduce the impact of any individual stock’s performance on the general fund.
4. Potential for active risk management
These funds allow for active risk management strategies. The fund manager can actively monitor and mitigate risks by continuously assessing the portfolio’s performance and making timely adjustments.
This is particularly important because of the type of fund and the risk exposure. In case of a focused equity fund, the risk exposure is quite high. Because the entire portfolio is concentrated, rapid risk management is essential.
This proactive approach helps minimize downside risks and preserve capital during market downturns.
5. Alignment with long-term goals
They are suitable for investors with a long-term investment horizon. Please note that, like with most equity funds, focused equity funds are also recommended with a longer investment horizon. There may be some ups and downs in the short term due to market volatility.
By investing in high-conviction stocks, these funds align with the investor’s long-term goals, such as wealth creation, retirement planning, or funding education expenses. The focused approach provides the potential for compounding returns over time.
How to choose a focused equity fund to invest in?
Selecting the right focused equity fund is crucial to maximize the potential benefits and align with your investment goals. Here are some key factors to consider when choosing a focused equity fund in the Indian markets:
1. Track record
Evaluate the fund’s historical performance and consistency over different market cycles. Look for funds that have consistently outperformed their benchmark index and peers in the long term.
However, remember that past performance does not guarantee future results. Historical returns are best used in combination with the other evaluation parameters.
2. Fund manager expertise
Assess the experience, expertise, and track record of the fund manager. A skilled and knowledgeable fund manager can significantly impact the fund’s performance. Research the fund manager’s investment approach, philosophy, and ability to generate alpha.
Please remember that the fund manager is the one who will be in charge of managing the portfolio. They will be taking active decisions about asset allocation. It is very important to make sure their investment approach aligns with yours.
3. Investment philosophy
Understand the fund’s investment philosophy and whether it aligns with your investment beliefs. Some funds may have a value-oriented approach, while others may focus on growth or combining both.
While both of these sound similar, there may be quite a difference in the long run. Choose a fund that resonates with your investment style and objectives.
4. Expense ratio
Consider the fund’s expense ratio, which includes management fees and other operating expenses. Lower expense ratios can have a positive impact on your overall returns. Compare the expense ratios of similar funds and choose the one offering a reasonable cost structure without compromising quality.
5. Risk management approach
Look for funds that have a robust risk management framework in place. Assess how the fund manages risks associated with concentrated portfolios, such as monitoring stock-specific risks, diversification within concentration, and managing overall portfolio volatility.
Focused equity funds have become a strategic investment option in the Indian markets. By concentrating investments in a select number of high-conviction stocks, these funds aim to deliver potentially higher returns while actively managing risks. The various types of focused equity funds, including sector-specific, theme-based, and multi-cap, provide investors with choices to align their investments with specific market trends, sectors, or themes.
However, it is important for investors to carefully evaluate the fund’s track record, the expertise of the fund manager, and their own risk tolerance before investing in focused equity funds. Consulting with a financial advisor can provide valuable insights and help investors make informed investment decisions.
In conclusion, focused equity funds provide an avenue for investors to unlock the potential of the Indian markets by concentrating their investments in carefully chosen stocks. With the right research, active management, and a long-term perspective, investors can harness the benefits of focused equity funds and potentially achieve their investment objectives.
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