Introduction
Mutual fund investment strategies cater to diverse investor goals and risk tolerances. One approach is focused or concentrated investing, it targets a select number of carefully chosen stocks, aiming for high returns. They offer potential for outperformance but carry risks like concentration and stock-specific risks. Here, we’ll explore the features, types, risks, and potential returns of focused funds.
What are Focused Funds?
Focused mutual funds, also known as concentrated or under-diversified funds, Unlike diversified funds that spread risk across many holdings, focused funds invest in a small number of carefully chosen stocks, typically no more than 30. This concentrated approach allows fund managers to make “high-conviction” bets on companies they believe have strong growth potential.
How do Focused Funds work?
Focused funds invest in a limited number of carefully chosen companies believed to have strong growth potential. They are actively managed, with the fund manager strategically deciding which stocks to buy and how much to invest in each, based on thorough analysis. The goal of these funds is to outperform the market by capturing significant gains from these high-conviction holdings. However, to manage the inherent risk of concentration, focused funds still diversify across sectors and conduct rigorous analysis of each company they invest in.
Features of Focused Funds
Features of Focused Funds are:
- Concentrated Portfolio: This allows for in-depth research and focus on high-conviction investment ideas.
- High-Conviction Investing: Fund managers prioritise stocks believed to have exceptional growth potential and the ability to outperform the market over the long term.
- Active Management: Focused funds rely on the expertise of experienced managers who actively research, select, allocate assets to, and adjust holdings based on market conditions.
- Risk Management: While aiming for high returns, focused funds employ risk management strategies like diversification across sectors and thorough analysis to mitigate the inherent concentration risk.
- Long-Term Focus: Focused funds seek sustainable wealth creation by identifying fundamentally strong companies suitable for long-term investment.
- Potential for Outperformance: By focusing on high-quality stocks with significant upside potential, focused funds aim to outperform broader market indices and diversified funds.
Risks and Returns
Before investing in Focused mutual funds, it’s important to understand both the potential benefits and drawbacks:
Returns
- Potential for High Returns: Focused funds have the potential to deliver high returns compared to broader market indices and diversified funds. By concentrating investments in a select number of high-conviction stocks, focused funds aim to capture significant upside potential when these stocks outperform the market.
- Outperformance: Focused funds may outperform diversified funds during periods when the fund manager’s investment decisions are successful. The concentrated portfolio allows for more targeted exposure to specific themes or opportunities, potentially leading to outperformance if the chosen stocks perform well.
- Active Management: Focused funds are actively managed, allowing the fund manager to capitalise on market inefficiencies and adjust the portfolio based on changing market conditions. Skilled fund managers may exploit mispricings or identify undervalued opportunities, contributing to potential returns.
Risks
- Concentration Risk: The primary risk associated with focused funds is concentration risk. Since these funds hold a limited number of stocks, the performance of the entire portfolio may be heavily influenced by the performance of a few key holdings. If one or more of these holdings underperform, it can have a significant impact on the overall fund performance.
- Stock-Specific Risk: Focused funds are susceptible to stock-specific risks associated with individual holdings. Adverse developments, such as poor financial performance, management issues, or industry disruptions, can negatively impact the performance of specific stocks within the portfolio.
- Market Volatility: Focused funds are subject to market volatility, which can affect the performance of both the fund’s underlying stocks and the overall portfolio. Market fluctuations, economic events, and geopolitical factors may lead to short-term price volatility and affect the fund’s returns.
- Lack of Diversification: Focused funds lack the diversification benefits offered by traditional diversified funds, as they concentrate investments in a limited number of stocks. This lack of diversification increases the fund’s vulnerability to adverse events affecting specific sectors, industries, or individual companies.
- Manager Risk: The performance of focused funds is highly dependent on the skill and expertise of the fund manager. Poor investment decisions, suboptimal stock selection, or ineffective portfolio management can adversely impact fund performance and investor returns.
Conclusion
Focused funds offer investors the opportunity for potentially high returns through concentrated investments in carefully chosen stocks. While they present the chance for outperformance, they also carry risks such as concentration, stock-specific factors, and market volatility. However, investors should recognize and manage risks and its suitability to make informed decisions.
Disclaimer: The views expressed here are of the author and do not reflect those of Dhanvantree. Mutual funds are subject to market risks, please read the scheme documents carefully before investing.