Focused equity funds have cyclicality of performance: How to pick the best one?

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Focused equity funds have cyclicality of performance: How to pick the best one?


All mutual fund schemes go through cycles of performance. This is not only about the market’s bull and bear cycles, but also about mutual fund schemes, which are a basket of stocks with their unique nature and individuality. There are times when a particular industry or sector of the market is doing well, but a fund being a collection of multiple stocks, goes through its own unique cycles as well.

This cyclicality is more relevant for focused equity funds, as these are concentrated bets as per the view of the fund manager or the stated investing theme. Investing in equity funds essentially means going with the fund manager’s calls on stock selection. For an investor opting for focused funds, there is an understanding that he/she is more comfortable with concentrated bets over diversification within diversification i.e. selecting multiple funds with a large diversified portfolio.

The investment universe being considered here is largecap stocks or relatively largercap stocks. To understand the reason why focused equity funds are concentrated bets, we have to look at the Sebi framework that define the ground rules.

It is defined as “a scheme focused on the number of stocks (maximum 30)” and “that mentions where the scheme intends to focus on, viz., multicap, largecap, midcap, smallcap.” Generally, across equity mutual fund categories, there is no cap on the number of stocks a scheme can hold, providing fund managers with ample flexibility in portfolio construction.

However, focused funds are about taking concentrated bets i.e. investing in a small number of high conviction names. From that perspective, even 30 is not restrictive. We can debate what the optimum level of diversification is, but as long as a portfolio is spread across industries and sectors, 30 is adequate.

Now let us come to cyclicality. The funds considered here have a corpus size of more than Rs 1,000 crore and is of regular (non-direct) option. Fund performance data considered is as of March 12, 2021. This filter ensures that the universe considered includes funds across asset sizes but excludes those which are yet to gather minimum traction.

In terms of fund performance, on a three-year and five-year basis, IIFL Focused Equity Fund and Axis Focused 25 have done well. But over the last one year, both these funds have lost ground and have slipped in the peer group ranking. The ones leading the charts over the past one year is a different set of names – ICICI Prudential Focused Equity Fund and Nippon India Focused Equity Fund.

To reiterate the point on cyclicality, just like industries and stock markets, fund performance too goes through cycles. Since focused funds are fund manager’s high-conviction bets, it is also expected to go through cycles. The funds which have been doing well over the last one year are those which could read the shit in the economy and markets at large during the disruptive times of a global pandemic.

As an investor, when it comes to investing in a focused fund, other than considering the long-term performance track record, it is imperative to check if the fund manager has been successful in rotating the portfolio as per the changing economic/market conditions. This will provide the conviction to pick and stay invested in the select fund. It is important to remember that there could be phases where a particular fund tends to do very well and when the market cycle shifts, these funds are unable to respond to the changing times and hence tends to underperform in the rest of the market cycle.

So, what is important is the fund manager’s ability to respond with ease to the shifts seen from time-to-time.

Conclusion

The key when it comes to investing in a focused fund is to be convinced oneself about the stock-picking skill of the fund manager. Focus on funds that can be nimble in terms of portfolio construction and have a performance track record. The optimal approach when investing in such a category would be to invest in a staggered manner through SIP or STP than trying to time the market.



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