Rajini style: How, why a mutual fund delivers 20%+ returns

How shallow and incomplete would an answer be if one replied, "He is a superstar", to a "Who is Rajinikanth?" question?

That would do such a disservice to his acting prowess, early-day struggles, and subsequent meteoric rise.

Similarly, just reading the headline of a mutual fund delivering 20 per cent-plus returns and then mindlessly investing in them would be equally frivolous. That's because a mutual fund's success, like Rajinikanth's, isn't built in a day.

So, let's trace the journey of a successful mutual fund from its humble beginnings to understand what has made it tick so far.

Phase 1: Audition
Let's take any random mutual fund that has delivered strong double-digit returns in the recent past.

Ok, my eyes fall on Kotak Focused Equity Fund . It has delivered an eye-catching 24.2 per cent return in the last three years.

Phase 2: Rigorous rehearsal
Since the key ingredient to success is preparation, let's trace the fund's gruntwork in its initial days.

While Kotak Focused Fund received little over Rs 1,000 crore from investors when it launched in July 2019, it invested only Rs 109 crore across 19 stocks, as per its first portfolio disclosure.

The rest of the money was in cash and yet to be invested, as you can see in the table below:

It took a full four months for the fund to deploy almost all of the money in equity.

That tells you one thing: portfolios aren't built overnight, either. A lot of research goes into picking stocks.

Phase 3: Light, camera, action
Just like you can't fake it in front of a camera, there's no hiding for fund managers once they have built the portfolio. They now need to closely monitor it.

The moment they lose conviction in a business, they sell. The opposite is true too.

It's no different with Kotak Focused Fund. Let's look at what happened with the first bunch of 30 it had invested in:

While 20 per cent of the initial companies were sold within a year, nearly 45 per cent of them were retained for more than three years. This simply illustrates that a fund manager needs to have conviction and ruthlessness in equal measure to thrive in an ultra-competitive mutual fund landscape.

But this story doesn't end here because its growth, like everything else, hasn't been linear.

Phase 4: Navigating the highs and lows of stardom
As big a star as the Thailava (as Rajinikanth is known as) is, even he has had his share of highs and lows. (Don't believe the memes, he bleeds just like the rest of us).

So, why would a fund be any different?

Kotak Focused Fund is roughly four years old. Since its launch, it has invested in 61 stocks, and the results are a mixed bag, as you can see in the below table.

At this point, you may ask, "If the fund's individual stock-picking is so patchy, how has this fund given high index-beating returns?" Put simply, it's a game of having bigger winners than losers.

Another critical aspect is what percentage of money is allocated to each stock. You can clearly see that the sizing of the winners is more significant than the losers. It is these numbers that make these funds deliver high double-digit returns (as of May 23, 2023).

Phase 5: Achieving super-stardom
Each year tells a different tale. Just as not all Rajinikanth's movies are super-duper, mega-monster hits, the Kotak fund has also had its share of blockbuster years and lacklustre ones.

As you see above, 2021 was a great year, but before that, it was at par with what equity funds usually deliver.

In short, your returns will be lumpy. Some great years will make up for the mediocre ones.

So, the next time you see an alpha mutual fund, do not get enamoured by its success or headline returns alone. Because people (and mutual funds) work hard in silence, success is just noise.

Suggested read: A practical guide to choose the right mutual fund

This article was originally published on June 06, 2023.