What are focused funds? Why should one invest in focused funds?

The focused funds are an interesting topic they are both side argument for it one is in favor of focused funds and the other is against focused funds. A focused fund, as the name suggests, is a mutual fund with a larger focus on specific themes. These themes could be broad stories like consumption, commodities, rate sensitivity, technology enablement, FinTech etc. The argument in favor of Focused Funds is that it allows you to take a very granular approach to a theme. That is where outperformance really comes from. The argument against focused funds is that it goes against the basic grain of mutual fund investing; which is all about diversification of risk. A focused fund actually concentrates risk. Having said that; there is a definite value that focused funds can add to your portfolio! Here is how…

  1. Some themes work for some time; so as well make the best of it…

This needs no reiteration. If you look at the performance of thematic stocks versus the Nifty during their tipping periods, it is a clear case of outperformance. Take Infosys and Wipro during the late 1990s; take capital goods and power companies in the mid-2000s; take private banks in the last 5 years; take FMCG in the last 1 year. These are all cases of specific themes vastly outperforming the index by a huge margin. Just look at how Hindustan Unilever, Reliance, and Britannia have performed versus the index. All these 3 large stocks are up by more than 50% in the last 1 year. The theme, of course, has been consumed.

  1. Focus on themes that are sustainable; not on random fads…

How do you differentiate between a theme that lasts and a theme that is fad? Themes that sustain over a period of time can actually outperform the diversified equity funds, but the challenge is in identifying these themes.  Your strategy should be to look for themes, that have a huge market potential, have the scale of business, are creating profits and also building on ROE. That is what will make a theme sustainable.

  1. Don’t have to look at 3000 listed stocks in the market…

When you select diversified equity as your theme, the entire universe of stocks is in front of you. What to track and how to track are major challenges. That problem is partially resolved in case of thematic funds since your focus will now be on a much smaller set of stocks. Since your theme is quite clear; you just need to focus on tracking what is happening to the theme. You can monitor these stocks very easily and also track changes in these stocks.

  1. You can add and delete themes based on risk profile…

A thematic approach is not a fixed approach. IT was a theme once upon a time; capital goods and realty have also been key themes. Consumption is an interesting theme currently. You can approach as direct equities or as indirect equities. You can add themes to your portfolio by adding thematic stocks or even by adding thematic funds. When you add multiple themes, they give you an in-built diversification and reduce the overall risk in getting into thematic portfolios. Here thematic investing is all about classifying your entire equity portfolio into more granular themes.

  1. Even Buffett always preferred a small portfolio of themes…

At the end of the day, Alpha is what equities are all about. In India, a majority of the fund managers are able to beat the index. That is not the case in countries like the US where only 10% of the fund managers beat the index. Warren Buffett has always maintained his Berkshire portfolio in a handful of themes only. In the past it was Coca-Cola, then it was Wells Fargo and today it is Apple. But concentration is the theme of Buffett. As Indian markets evolve and finding alpha in diversified equities becomes more difficult, there may be no option but to shift to themes in a calibrated way. In fact, the big case for focused funds is that they can add that alpha to your equity portfolio.

  1. If you catch disruptions; you make a fortune in equities…

Did you know that an investment of Rs.10,000 in Wipro in 1980 would be worth Rs.500 crore today? More recently, an investment of Rs. 1 lakh in Havells in 1996 would be worth Rs.30 crore today. A small investment in Eicher Motors in 2001 would have multiplied nearly 1500 times in the last 17 years. That is the power of themes, which is what focused funds are all about! A diversified approach cannot help you to identify the big disruptions. That is only possible when you adopt a thematic approach.

It is very likely that you are confused about whether to opt for diversified equity funds or for thematic funds. They are not exactly an either/or option for you. Your core portfolio in mutual funds should still consist of diversified equity funds only. These thematic funds and focused funds can be a small part of your overall portfolio to create that added alpha. Keep that in perspective!

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