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Focused Funds - All you need to know

Not all mutual funds have a diverse investment mix. Instead, some limit the scope of their investments, focusing on a specific industry or company selection. Such mutual funds are referred to as focused funds.

What is a Focused Mutual Fund?

A focused fund is an equity mutual fund that invests in a small number of stocks. A focused fund can invest in up to 30 stocks as per the SEBI guidelines. Generally, other equity mutual funds hold between 50 and 100 stocks. Some focused mutual funds also indicate their goal of focusing on large-cap or mid-cap stocks. Other funds do not specify any such focus on category and follow an investment strategy for bottom-up stock selection. Focused funds aim to generate high returns by investing with growth potential in a small number of quality companies.

Why invest in Focused Funds?

Mutual funds' main objective is to provide full diversification. But beyond a limit, diversification is futile and can result in lower returns. The whole focused fund approach is to hit the eye of the bull with the right stocks and earn a high return. This requires the manager of the fund to buy stocks of material. This approach helps fund managers create a rigorous process for choosing stock for their portfolio.

There is also a higher risk (losses) for higher returns. Too much focus on a few stocks can either hit the bull's eye or completely miss the target. That being said, a skill can be an effective focus. The focused funds pursue a top-down strategy for selecting sectors and stocks and making determined bets on possible outperformers.

What investment strategy Focused Funds follow?

  • Generally investing in stocks at least 80% of assets.
  • Investing usually mainly in common stocks.
  • Investing normally in 30-80 stocks.
  • Investing in issuers from domestic and international land.
  • Investing in stocks that are either "economic" or "important" or both.
  • Use fundamental analysis of factors such as the financial condition of each issuer and the status of the sector, as well as market and economic conditions, to pick investments

Investment benefits in focused funds

Because they can only invest in so many stocks, focused funds are highly methodical and aim to select the best investment option that can work for the benefit of investors.

Focused fund managers are experts in the sectors in which they invest, and some of them have a history of picking winners and beating the wider stock market's returns.

Investment drawbacks in focused funds

While the narrow range of investments of a focused fund can sometimes produce market-beating returns, the lack of diversification can also put the fund at high risk. For example, if a concentrated fund invests solely in pharmaceutical companies, the value of its portfolio could collapse if some of its investments were experiencing significant regulatory setbacks.

If a few holdings go south, a diversified portfolio will not be sunk, as it will contain additional holdings that offset those losses. Focused funds have no such hedges in place, so they are much more volatile.

Besides, some focused fund managers take to the extreme the idea of concentration, which compounds risk and volatility.

Last Words

While diversification of a mutual fund (or lack of it) is an important consideration, bear in mind that other factors can play an equally important role. For example, savvy management and fees are also important factors in the overall performance of a fund. If you're not sure whether you're going to invest in a focused fund or a more conventional mutual fund, look at the big picture and see what option will help.

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