Focused equity funds are among the highest performing mutual fund categories in India. In this article, we look to at their construct, comparisons with multicaps and identify the top few performing focused equity funds.
The Republic of Gates & Buffett
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.
At a conference, Bill Gates & Warren Buffett were told to impart some wisdom. On a piece of paper, they wrote down one word that accounted for their success. And both wrote the exact same word — “Focus”.
Importance of Focus
Come to think of it, this is true of men and women around the world who are termed ‘successful’. They have been successful over many years and have achieved that distinction by being singularly focused on one craft. Bill Gates is focused 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.
Over a hundred years back it was Andrew Carnegie who held the world’s richest man title. He had over 300 billion dollars of wealth in today’s money. Andrew Carnegie held more wealth than Jeff Bezos, Bill Gates and Warren Buffett collectively.
Mr. Carnegie made his billions in personal wealth by creating a vertical monopoly in the steel industry. His companies controlled every aspect of the value chain from raw materials to production. He also controlled the transportation, distribution and even financing of stell.
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, focused equity funds and multi-cap funds are compared. And it won’t be entirely wrong to say that focused equity funds fall within the sub-set of multi-cap funds. That’s 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. Multicap funds often invest in 45 to 65 listed companies at any given time
- Focused funds have a very refined stock picking approach with the selected stocks having very strict screening criteria.
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 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 many cases, previous schemes were merged or renamed or transformed into a focused equity fund. This was done to comply with the SEBI Scheme Categorization circular which was issued on October 06, 2017. The objective of this change was to introduce better clarity for investors and bring uniformity in scheme categorisation. Now, all fund houses are required to have just one scheme per pre-defined category. The only exceptions to this are index or thematic funds.
Let’s understand this with an example.
Change in Configuration: Franklin India Focused Equity Fund
Franklin India Focused Equity Fund is the scheme with the highest AUM among focused equity funds. This fund was earlier called the Franklin India High Growth Companies Fund which was also 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. The Franklin India High Growth Companies Fund allocation to mid-caps and small-caps of over 50% for the entirety of 5 years (August 2009 to August 2014).
However since 2014, 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. It is highly possible that the fund might be using a different benchmark at different points of time.
Change in Configuration: SBI Focused Equity Fund
Another popular focused equity fund is the SBI Focused Equity Fund. This fund 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. This entire exercise of partaking this information to you is for you to have an understanding of which erstwhile fund has been transformed into a focused fund now.
Performance of Focused Equity Funds
We learnt that most focused equity funds had a different construct prior to 2017-2018. In light of this, it is important to have a greater weightage of the funds recent performance. This will lead to an an apples-to-apples comparison.
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 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 led the pack and 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. We can then see which funds tend to offer a consistent performance to your liking.
Performance of Focused Equity Funds over last 9 quarters
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 announced the guidelines to scheme categorization
Reading from this data might be rather difficult. That’s 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. Anything less than 6 quarters is a hugely insufficient time frame for me to make an evaluation of funds.
From the available rest, we see that there are five schemes which have done better than the others. These five schemes 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 four 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 good 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. 87% of the assets are in large cap and only 13% in mid-cap stocks. There is no allocation to small cap stocks.
The fund manager shows a preference for financial stocks at this current juncture. 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. It ranked in the top quartile of focused equity funds on most occasions. On a CAGR* basis, the fund has given returns of 11.8% over a two-year period. And has delivered14.5% over a one-year period.
* CAGR is an abbreviation for Compound Annual Growth Rate
IIFL Focused Equity Fund
This is a surprise to me.
I had always figured IIFL to be a debt player with sparse focus on equities. What surprised me was 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. Over a two-year period, the CAGR has been 12.1%. 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 these, 66% have been deployed in large cap stocks, 30% in mid cap and 4% in small cap stocks. 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. These two stocks have gained by 46% and 25% respectively over the last one year.
The IIFL Focused Equity Fund management team has done a brilliant job over the last 2 years. However, it is important to note that there has recently been a change in fund manager for this fund. From November 11, 2019, the reins of thefund 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. The AUM has zoomed in in the last three years. The AUM of this fund was a mere ₹700 crores in 2016 and has grown by 1200% by 2019. This growth in AUM is 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. In the last one year, the fund delivered 17.5% returns.
I have followed this fund for some time assessing its fund philosophy, how fund managers are evaluating opportunities and its risk management practices. These have helped the fund achieve high risk-adjusted returns. You can find more in-depth details about the Axis Focused 25 Fund in my dedicated blog post on 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. It focuses 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. Their funds stick to a high growth orientation which means periods of overachievement and underachievement. 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. The fund has 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. 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. This is exhibited in its high PE ratio of almost 40.
Overall, Motilal Oswal Focused 25 Fund has had some very good quarters of performance recently. This 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 just two quarters of performance in the top quartile. However, remarkably the fund has remained in quartile 1 or 2 for most part of the last two years. This shows remarkable consistency. The fund is like a Rahul Dravid class of fund that is mostly dependable and does not play glamour shots like hitting six sixes in an over
Unlike most focused equity funds, the SBI Focused Equity Fund has a good portion of its over ₹6,500 crores of AUM outside of large caps. The mid caps and small caps capture 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. The fund has delivered a CAGR of 13.4% over two years. The most recent year delivering a stellar 22.7% in returns.
On the portfolio front, I noticed that the fund has invested in Bharti Airtel which other focused funds 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.
The 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 – (1) the low hanging fruit (easy to do) or (2) a highest reward per effort taken or (3) 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 stock that the fund manager picks or retains a sizeable proportion of the assets is bound to be his top pick. His second pick or second highest proportion of assets is likely to be his second choice … and so on.
In other words, the 35th stock in the portfolio is expected to be the one which ranks 35th in the fund manager’s conviction. I read it this way – the more number of stocks attached to a fund, the lower is the portfolio return. And possibly this can 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.
The question on the riskiness of focused equity funds got me curious. I 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 oft used benchmarks. These are 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. Thus, fears around focused equity funds are more volatile and carry more risk is not warranted. They operate a lot like a multicap fund.
From the perspective of returns, the top multicap funds have delivered annual returns of 10.9% over five years. 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 like a retail PMS. PMS stands for portfolio management services. In a PMS, 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. Performance of 3 years or 5 years is avoidable as construct and the benchmark of these funds was different then
- 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 🙂
Additional Resources You Might Like
Here are some articles you might like:
- Rakesh Jhunjhunwala and his secrets to investing (Part 1)
- Building a high return portfolio with index funds – a step-by-step approach
- Complete SIP Investment Guide (over 8000 words compedium updated until 2020)
- The trillion dollar index fund story that John Bogle started in the 1970s
- Best SIP for achieving long term goals