Some sectors and stocks continue to do well, and out-do others be it in a bull rally or a bear pounding. Even within each sector, some stocks perform better than others while some will make your head hang in shame. This is why some investors prefer to stick to concentrated portfolios, which invest in the best ideas and large allocations give them a fighting chance to generate out-sized returns. A 2% weight to a stock that goes up by 50% in a year will not markedly impact the portfolio, but a 7% weight might. There are a quite a few funds in the industry that takes a focused approach, rather than choose a plain-vanilla diversified portfolio. Most of such funds have done well versus their respective category on a 3-year period, but some haven't when we look at 5-year time frame. To know more, read on.
Concentrated risks and returns
Like any other investment strategy, concentrated portfolios have received bouquets and brickbats depending on their performance. Many consider concentration in a portfolio as a sign of greater conviction. For a fund manager who is pretty sure that his/her ideas will work, strict diversification can be a problem. This is where a concentrated portfolio of 25-30 stocks can do very well compared to a basket of 50-60 stocks where everybody gets much lower allocation. The reverse situation can play out as well, because concentrated bets can lose a lot of money if the ideas flop. The larger the allocation, the bigger the losses will be in that unfortunate case.
That said, data has shown that accurate concentration is a gift. Sectors perform differently over years. This is why 'focus' funds try to select different sectors across market/economic phases, then use top-down investment approach to select potential outperforming sectors and finally arrive at concentrated sector bets. The trick is to spot the potential winners much ahead, and then invest in them like in any other strategy.
It is interesting to see how 'focus funds' manage the risk of concentration. Here is a look at how some funds do it.
The Axis Focused 25 Fund likes to think of itself as a diversified equity fund that invests primarily in the Top 200 stocks by market capitalization. It practices high conviction investing with a maximum of 25 stocks in the portfolio, but has embedded risk management system to counter portfolio concentration.
Similarly, the DSP BlackRock Focus 25 Fund has a high conviction portfolio consisting of 28 stocks currently. While the large-cap focused fund has no fixed style, it picks stocks from the top 200 stocks by market cap. It aims to mitigate risks by investing in companies with what it calls superior managements and stable cashflows.
The Rs 14,000-crore ICICI Prudential Focused Bluechip Equity Fund initially wanted to form a portfolio that is invested in equity and equity-related securities of about 20 companies belonging to the large cap domain and the balance in debt securities and money market instruments. Today, it has 50 stocks. The scheme follows a benchmark hugging strategy, to diversify better across sectors and reduce the overall concentration risk.
IDFC Focused Equity Fund has 28 stocks, again with large-cap bias. Its positive on private sector financials, consumer discretionary (including auto), and select industrials. The fund is underweight on technology and pharma sector. It has the flexibility to invest across sectors and across market cap. The focus is on companies with superior capital efficiencies.
The Rs 13,500-crore Kotak Select Focus Fund is an example of a multicap equity strategy with sectoral focus. The fund's portfolio composition is around 55 stocks. It aims to take concentrated sector bets but diversified at stock level.
Other funds with the 'focus' tag include Motilal Oswal MOSt Focused 25 Fund, Motilal Oswal MOSt Focused Midcap 30 Fund, Motilal Oswal MOSt Focused Multicap 35 Fund, Reliance Focused Large Cap Fund, Sundaram Select Focus Fund and Union Focussed Largecap Fund.
Returns and performance
At the end of the day, any mutual fund is all about returns. Investors care about gains. So, let us look at how focus has paid off in these funds. Some of these funds have done some heavy-duty portfolio churning as well, with ICICI Prudential Focused Bluechip Equity Fund, IDFC Focused Equity Fund and Axis Focused 25 Fund sporting portfolio turnover of over 100%, which indicates complete overhaul. Two schemes, i.e., Kotak Select Focus Fund and Motilal Oswal MOSt Focused Multicap 35 Fund haven't churned much (portfolio turnover below 40% level), probably because their picks have clicked.
The bull rally in last one year clearly shows up in the gains racked up by focus funds. Given that most of these fund had big positions on companies geared to benefit from consumption, it's been good tiding for them. We at Value Research like to look at 3 year and longer time periods to assess funds more accurately. Plus, we looked at how these 'focus funds' did vis-a-vis category returns and also respective benchmark returns.
Here is a snapshot of how 'focus funds' performed individually.
|Scheme Name||Category||Benchmark||1 yr return||3 yr||5 yr||10 yr|
|Axis Focused 25 Fund||Multi Cap||Nifty 50 Index||26.92||17.26||18.56||-|
|DSP BlackRock Focus 25 Fund||Large Cap||S&P BSE 200||14.78||13.58||18.36||-|
|ICICI Prudential Focused Bluechip Equity Fund||Large Cap||Nifty 50 Index||18.86||11.97||17.55||-|
|IDFC Focused Equity Fund||Large Cap||Nifty 50 Index||32.76||12.85||15.01||10.57|
|Kotak Select Focus Fund||Multi Cap||Nifty 200 Index||22.32||17.36||22.05||-|
|Motilal Oswal MOSt Focused 25 Fund||Large Cap||Nifty 50 Index||21.84||15.27||-||-|
|Motilal Oswal MOSt Focused Long Term Fund||Tax Planning||Nifty 500 Index||34.23||-||-||-|
|Motilal Oswal MOSt Focused Midcap 30 Fund||Mid Cap||Nifty FF Midcap 100||14.47||20.13||-||-|
|Motilal Oswal MOSt Focused Multicap 35 Fund||Multi Cap||Nifty 500 Index||31.94||25.66||-||-|
|Reliance Focused Large Cap Fund||Large Cap||Nifty 50 Index||17.09||11.04||16.74||8.25|
|Sundaram Select Focus Fund||Large Cap||Nifty 50 Index||22.17||9.47||13.97||8.44|
|Union Focussed Largecap Fund||Large Cap||S&P BSE 100 Index||-||-||-||-|
|Data as on 18/09/2017, Portfolio data as on 31/08/2017|
A detailed analysis throws up interesting observations. Firstly, in the last 3 years, all focus funds have done better than their respective categories. The biggest alpha was seen in Motilal Oswal MOSt Focused Multicap 35 Fund that grew by 25.66% annually in 3 years compared to multicap category jumping by about 14%. The fund's performance over benchmark Nifty 500 is even better, since the scheme has given nearly 2.5 times the benchmark return. On the other end of the spectrum, large-cap oriented Sundaram Select Focus Fund has failed to beat the category return in these 3 years. Reliance Focused Large Cap Fund has barely managed to beat its category as well. All the funds, however, have beaten their respective benchmarks.
Secondly, if we look at a slightly longer period say 5 years, some focus funds have clearly not been able to keep their 'focus' intact. Only 71% of funds have done better than respective category in 5 years time-frame. Two funds, namely Sundaram Select Focus Fund and IDFC Focused Equity Fund have actually failed to beat category average. On the other hand, DSP BlackRock Focus 25 Fund and Kotak Select Focus Fund have the broadest margins over respective category average in 5 years. Compared to benchmarks, 100% of funds in 5 year time period have done better.
Thirdly, there are not too many funds with a decade long operating history in 'focus funds' space. However, 2 out of 3 funds have failed to beat category average in 10 year time-period. Reliance Focused Large Cap Fund has under-performed both its benchmark Nifty 50 and also its large-cap category average in these 10 years, albeit by thin margin.