Bill Gates and Warren Buffett have been on the top 10 wealthiest people in the world list for a decade or more now. Currently they have a combined wealth of $180 billion.
To put that into perspective, if the “Republic of Gates & Buffett” were a country then they would be number 53 in the list of countries as per GDP (Gross Domestic Product). And their combined net worth would be greater than countries like Kuwait, Sri Lanka, Kenya and Hungary.
The Republic of Gates & Buffett has two chief exports – a) philanthropy and b) wisdom. So, when Bill Gates & Warren Buffett were told to impart some wisdom and were given a piece of paper to write down one word that accounted for their success — both wrote the exact same word — “Focus”
Come to think of it, the men and women around the world who are termed ‘successful’ over many years have achieved that distinction by being singularly focused on one craft – Bill Gates with software, Warren Buffett with investing, Roger Federer with tennis, Andrew Carnegie with steel industry, JP Morgan with banking, Amitabh Bachchan with acting, Stephen King with writing, Michael Jackson with pop, Steven Spielberg with film-making .. and the list goes on.
The name of Andrew Carnegie pops out for me. Because while Amazon’s Jeff Bezos, Microsoft’s Bill Gates and Berkshire Hathaway’s Warren Buffett continue to take turns with the world’s richest man title, over a hundred years back it was that man Andrew Carnegie who held the world’s richest man title with over 300 billion dollars of wealth in today’s money. Andrew Carnegie held more wealth than Bezos, Gates and Buffett collectively.
Mr. Carnegie made his billions in personal wealth by creating a vertical monopoly in the steel industry wherein his companies controlled every aspect of the value chain from raw materials to production to transportation to distribution and even financing.
People loved to follow the habits of rich people and everyone in America wanted to be like Mr. Carnegie. Young men from far and wide would approach him for advice and Mr. Carnegie would always say the same one thing – “Put all your eggs in one basket, and then watch that basket very carefully”
Let’s take Mr. Carnegie’s advice into the world of investing and examine a certain category of funds called the “Focused Equity” funds.
What are Focused Equity funds?
Focused equity funds are a type of equity mutual funds that invest in a limited number of stocks. These funds have a wide investment universe with no restrictions on market capitalization or sectors where they can invest.
Often, a lot of comparison is done between focused equity funds and multi-cap funds. And it won’t be entirely wrong to say that focused equity funds fall within the sub-set of multi-cap funds because both these categories of funds are expected to participate in investment opportunities across market capitalizations and sectors.
I see two key differences between focused funds and multi-cap funds –
- Focused funds cannot invest in more than 30 companies as mandated by SEBI (Securities and Exchange Board of India). On the other hand, there is no such capping for multicap funds and it is often seen for them to have an investment across 45 to 65 listed companies at any given time
- Focused funds seem to have a very refined stock picking approach (refer to my analysis of the Axis Focused 25 Fund in a different post) with the selected stocks having very strict screening criteria. As multi-cap funds are more broad based i.e. there are a lot more securities, it seems to me that the fund managers of multi-cap funds are more cavalier in their stock picking techniques and can make some judgement calls
Schemes under the Focused Equity Fund category
At the time of writing this article, there are 22 funds in the “Focused Equity” category.
The launch date* of each of these funds and the AUM (assets under management) are available in the table below (as on 04.01.2020) –
*A word of caution here with re: launch date. In a number of cases, previous schemes were merged or renamed or transformed into a focused equity fund to comply with the SEBI Scheme Categorization circular which was issued on October 06, 2017. The objective of this change by SEBI was to introduce better clarity for investors and bring in uniformity in the categorisation of schemes. Now, all fund houses are required to have just one scheme per pre-defined category with smaller exceptions like index or thematic funds.
Let’s understand this with an example.
Franklin India Focused Equity Fund, the scheme with the highest AUM among focused equity funds, was earlier called the Franklin India High Growth Companies Fund which was one of the more popular schemes floated by the fund house. The change in name was effective from June 4, 2018.
However the name was not the only change. The fund house has also changed the construct of the new fund. For one, the allocation to mid-caps and small-caps has changed quite a bit with the Franklin India High Growth Companies Fund having an allocation to mid-caps and small-caps of over 50% for the entirety of 5 years (August 2009 to August 2014).
However since then, the proportion of mid and small caps has been brought down steadily and in August 2018, when the announcement of the transformation to Franklin India Focused Equity Fund was made, the mid cap and small cap component of the fund was just 25%. I bring this point out because comparing the fund’s performance with the benchmark might be difficult because the fund might be using a different benchmark at different points of time.
Similarly another popular focused equity fund is the SBI Focused Equity Fund which was originally launched in October 2004 as SBI Emerging Businesses Fund. The erstwhile SBI Emerging Businesses Fund was geared towards mid cap and small cap investments. I looked at the October 2017 report from SBI Mutual Fund and found that 27% of the assets were in large cap funds while 68% of the assets were in mid and small cap funds.
Again, I’d like to re-emphasize that the point here is not how much of assets were in large and mid/small cap companies but the entire exercise of partaking this information to you is to have an understanding of which erstwhile fund has been transformed into a focused fund now.
Performance of Focused Equity Funds
In the earlier section of this post, we learnt that most focused equity funds had a different construct prior to 2017-2018 when these changes started to take shape. In light of this, it is important to have a greater weightage of the funds recent performance so as to make an apples-to-apples comparison.
Just for reference sake, I am submitting the 6 month, 1 year, 2 year, 3 year and 5 year annual returns of the top few focused equity funds. Kindly take these numbers esp. the 3 year and 5 year CAGR with a pinch of salt and choose to ignore the same.
The above data shows that the Axis Focused 25 Fund has lead the pack as it has the top spot in terms of performance in the 3Y and 5Y returns category. Axis Focused 25 Fund is followed by IIFL Focused Equity Fund and the SBI Focused Equity Fund.
More recently, we see that the IIFL Focused Equity Fund has offered superlative performance in the 1Y and 2Y bracket.
Since benchmarking performance on the basis of 3Y or 5Y or even 2Y is difficult, a more effective strategy in case of focused equity funds is to look at quarter on quarter returns offered by the funds and then see which funds tend to offer a performance of your liking which generally comes down to consistency vs high return
Here is how the focused equity funds have performed over the last 9 quarters (I have used the quarter starting Oct 2017 because that’s when the SEBI announcement with regards to scheme categorization had come in)
Reading from this data might be rather difficult, which is why it will be a good idea to rank the performance of each scheme for every quarter. This will certainly help in understanding the relative position of each fund in a very readable manner.
Here are the quarterly rankings for every focused equity fund
My first step will be to ignore some funds which are more recent in existence. These would be the Mirae Focused Equity Fund, Kotak Focused Equity Fund, Union Focused Equity Fund and the most recent of the lot, the Tata Focused Equity Fund. These have been in play for only 1 or 2 quarters which is a hugely insufficient time frame for me to make an evaluation of these funds for the purpose of ranking.
From the available rest, we see that there are five schemes which have done better than the others and have spent a reasonable amount of time in the top quartile (i.e. within the top 25%) of funds performance. I am presenting the quartile table below for a better assessment.
Let’s look at some of these chosen focused equity funds
Sundaram Select Focus Fund
Sundaram Select Focus Fund was in the top quartile in 5 out of the possible 9 quarters in our analysis. On the flip side, the 4 occasions when the fund was not in the top quartile, it was in the third and fourth quartile of performance. But such is the nature of the beast and you can expect funds to be unable to replicate brilliant performance every quarter.
Sundaram Select Focus Fund has over ₹1,000 crores of assets under management. The portfolio is currently almost completely skewed to companies with large market capitalisations with 87% of the assets in large cap and only 13% in mid-cap stocks. There is no allocation to small cap stocks. The fund manager also shows a preference for financial stocks at this current juncture with 6 of the top 8 holdings of the scheme consisting of companies in the financial space. Financial companies which consist of banks, insurance companies and NBFCs comprise 46% of Sundaram Select Focus Funds’ AUM.
The last 9 quarters show that Sundaram Select Focus Fund has performed quite well and has been ranked in the top quartile of focused equity funds. On a CAGR (Compound Annual Growth Rate) basis, the fund has given returns of 11.8% over a two-year period and 14.5% over a one-year period.
IIFL Focused Equity Fund
I must say, this was a surprise to me. I had always figured IIFL to be a debt player with sparse focus on equities. I was sort of correct here and figured that the IIFL Focused Equity Fund is the only equity fund that this fund house has launched.
And what a launch it turned out to be. The IIFL Focused Equity Fund has delivered an eye-popping 27.6% returns in the last one year and 12.1% return over a two-year period. The fund has been in the top quartile in each of the last four quarters and has held to that top quartile tag in 5 of the last 7 quarters.
IIFL Focused Equity Fund currently has ₹476 crores in assets as of Nov 2019 of which 66% have been deployed in large cap stocks, 30% in mid cap and 4% in small cap stocks. A look at the portfolio reveals that the raison d’être of such superlative performance has been the fund manager’s wholesome conviction on the two banking giants – ICICI Bank and HDFC Bank – who have gained by 46% and 25% over the last one year.
While the IIFL Focused Equity Fund management team has done a brilliant job over the last 2 years, it is important to note that there has recently been a change in fund manager for this fund. With effect from November 11, 2019, the fund manager of the IIFL Focused Equity Fund has changed from Prashasta Seth to the new fund manager, Mayur Patel.
Axis Focused 25 Fund
The Axis Focused 25 Fund is one of the largest funds in the Focused Equity space with an AUM of over ₹8,800 crores. What makes this number remarkable is that just three years back, the AUM of this fund was a mere ₹700 crores and has grown by 1200% in these three years. This growth in assets under management is also entirely attributable to the fund’s performance over the last few years and quarters.
The fund has performed exceedingly well and has delivered returns of 12.7% over a 2-year period and 17.5% in the last one year. Axis Focused 25 Fund is a fund I have followed for some time now in terms of assessing its fund philosophy, how fund managers are evaluating opportunities and its risk management practices which can ensure high risk adjusted returns. You can find more in-depth details about the Axis Focused 25 Fund in my dedicated blog post to this fund.
Here’s a quick summary of the five elements you’ll read up in the post –
- The fund follows a growth style of investing with focus on a business’s ability to grow predictably, generate incremental free cash flow and maintain industry leadership.
- Avoidance of investing in public sector enterprises
- Classification of portfolio into core, cyclical and emerging themes
- Invest in companies with high ROE (return on equity), high ROCE (return on capital employed) and high NM (net margin)
- Invest with a high level of conviction which includes taking big positions in some companies
Motilal Oswal Focused 25 Fund
Equity funds offered by Motilal Oswal are often labelled as more aggressive than others. This means, their funds mostly stick to a high growth orientation which allows for periods of overachievement and also periods where they wear the underachiever’s tag. There is nothing wrong in having a different playing style as long as the fund house is consistent about it.
Motilal Oswal Focused 25 Fund has a little over ₹1,100 crores of AUM spread over a smallish portfolio of only 21 stocks. The fund generally keeps a very concentrated portfolio of between 20 and 24 stocks. And consequently the top 10 stocks in its portfolio carry over 70% of the overall portfolio weight for this fund. Another observation here is that the fund does not mind paying a hefty premium as it chases stocks which can offer high growth potential over the medium to long term which is exhibited with a high fund PE ratio of almost 40.
Overall, Motilal Oswal Focused 25 Fund has had some very good quarters of performance recently which shows in its 2-year CAGR of 9.0% and a 1-year return of 18.7%.
SBI Focused Equity Fund
This fund has had two quarters of performance in the top quartile but remarkably has remained in quartile 1 or quartile 2 for most part of the last two years which shows remarkable consistency. Think of the SBI Focused Equity Fund more like a Rahul Dravid sort of fund that is mostly dependable but seeks not to play the glamour shots like hitting six sixes in an over
Unlike a number of other focused equity funds, the SBI Focused Equity Fund has a good portion of its over ₹6,500 crores of AUM outside of large caps with mid caps and small caps capturing almost 40% of the investments by this scheme. And this comes inspite of having just 22 companies in its portfolio at this time.
The fund manager’s stock picks have really helped garner excellent returns with a CAGR of 13.4% over two years and the most recent year delivering a stellar 22.7% in returns. On the portfolio front, I couldn’t help but notice that the fund has invested in Bharti Airtel which most of the other focused funds seem to have skipped. Additionally over 3% of the assets have been invested internationally in Alphabet Inc. Class C shares
Are focused equity funds riskier than multicap funds?
This question has been asked of me in different ways. Are focused equity funds risky? Aren’t focused equity funds more volatile? How do fund managers tackle this additional risk they are taking by selecting only 25-30 stocks in the fund portfolio?
All are valid concerns. Because focused equity funds carry a concentrated portfolio, it is deemed to carry more risk because a single error in judgement can bring the entire portfolio’s performance down.
Decision making framework
Let’s look at this question from the point of view of how we take decisions.
In an environment where we have to make a choice, we generally tend to opt for the best possible choice which can be a low hanging fruit (easy to do) or a highest reward per effort taken or a choice that gives the greater good. But almost never, will you start with an option which might be the 6th best or 15th best option.
My assessment of what constitutes a portfolio also mimics the same way we make decisions. So the first fund that the fund manager picks or the stock which he retains with a sizeable proportion of the assets is bound to be his top stock pick which will light the road on fire. His second pick or second highest proportion of assets is likely to be his second choice … and so on.
Which means – the 35th stock in the portfolio is expected to be the one which ranks 35th in the fund manager’s conviction. For me, this means that the more stocks are attached to a fund, the lower will be the portfolio return and possibly even increase the risk to the portfolio.
Here’s a quote by Phil Fisher that sums up the diversification predicament that many face.
“Investors have been so oversold on diversification that fear of having too many eggs in one basket has caused them to put far too little into companies they thoroughly know and far too much in others which they know nothing about.”Phil fisher (1958)
In an article “How Many Stocks Should You Own In Your Portfolio?”, the author Sean Stannard-Stockton has argued that beyond a point the benefits of diversification decay rather quickly. The range of stocks in a portfolio beyond which diversification does not help much is 20-25 … which is pretty close to where most of our focused equity funds are at.
Since the question on the riskiness of focused equity funds got me curious, I then pulled out the quarterly performance numbers of the top focused equity funds and the top multicap funds over the last 5 years to understand where we stand on this.
For this, I compared the performance of focused equity and multicap equity funds with a couple of often used benchmarks – the Nifty 50 and the Nifty 200 index. Here’s a chart that shows how the average focused equity fund has moved when compared to a multicap fund over the last 5 years
An examination of the results revealed that there is no particular difference in the movement of a focused equity fund as compared to a multicap fund. Which means the fears that focused equity funds are more volatile and carry more risk is just not warranted. They operate a lot like a multicap fund.
From the perspective of returns, over the last 5 years, the top multicap funds have delivered annual returns of 10.9% while the top focused equity funds have fared slightly better with an annual return of 11.3%.
When compared to the two benchmarks, I find that the returns of focused funds and multicap funds are far higher than the benchmarks. The Nifty 50 and the Nifty 200 in the same five period returned a cumulative annual return of 7.9%.
To sum this difference, the data indicates that focused funds are not more volatile than multicap funds and that they perform slightly better than multicap funds.
Let’s summarize what we have learnt in this post –
- Focused equity funds are a lot like a retail PMS (PMS stands for portfolio management services wherein a professional money manager constructs your investment portfolio in equities, fixed income, debt, structured products etc. tailored to your needs and objectives. PMS services in India generally start with an investment of ₹50 lacs and upwards)
- Focused equity funds offer adequate diversification with participation in 20-30 stocks. They operate like multicap funds such that they participate in opportunities across market capitalizations and sectors
- A number of schemes with different mandates were converted into focused equity funds in compliance with the SEBI scheme categorization circular in Oct 2017. As a result, it is wise to examine the performance of these schemes from Oct 2017 onwards rather than looking at 3 years or 5 years data when the construct and the benchmark of these funds was different
- The featured focused equity funds in this post are –
- Sundaram Select Focus Fund
- IIFL Focused Equity Fund
- Axis Focused 25 Fund
- Motilal Oswal Focused 25 Fund
- SBI Focused Equity Fund
Focused Equity Funds are getting more warmth and it would make smart sense to have these funds in your portfolio in the form of an SIP (systematic investment plans)
Lets end this post on a lighter note 🙂