This category of equity funds has been spectacular at rallies, but it’s risky

Targeted equity funds invest in up to 30 stocks. There are a total of 22 schemes of this type managing Rs 44342 crore, as of May 2020, according to Value Research. Over a five-year period, category-focused capital funds have outperformed large-cap capital schemes. Although focused funds generated 5.51 percent, large-cap plans achieved 4.34 percent during this period on average.

During 2018 and 2019, a small group of stocks performed well, and investors holding those stocks made money. Some focused funds and diversified capital schemes with high exposure to such trending stocks also performed well. The table makes clear that in 2017, focused funds (with returns of 81.23 percent) substantially outperformed large-cap (30.92 percent) and multi-cap funds (36.68 percent). In 2018, bearish sentiment affected these funds and underperformed, although not significantly relative to other categories.

“In focused equity funds, the allocation to individual stocks is generally greater than that of a diversified equity fund. Some focused funds also have greater exposure to specific sectors. It makes the role of the fund manager important, ”says Anil Rego, founder and CEO of Right Horizons. For example, the SBI Focused Equity Fund invests 55 percent of its portfolio among its top 10 stocks. But on the other hand, the SBI Mangum Multi Cap Fund, a simple diversified scheme, has its top 10 stocks representing just 47 percent of the portfolio.

Although targeted funds have been recognized as a separate category by the Indian Stock Exchange Board (SEBI) in October 2017, many managers have followed it as a strategy in their regular schemes for years. Some of them made it to the focused category, while others are in other divisions, but still exposed to select stocks looking for high returns. For example, Axis Bluechip, a large-cap capitalization fund has consistently taken the focused investment route, consistently generating good returns. It had just 23 shares in its end-May portfolio and the top 10 shares accounted for 54 percent of the scheme’s corpus.

Major portfolio composition

Investors should verify the composition of the equity fund portfolio before deploying sums. Sometimes diversified equity funds also make concentrated bets to improve performance, which is a risky strategy. In the current market situation, most of these targeted funds have invested in large-cap stocks. However, some of them have exposure to small and mid cap stocks. Concentrated exposure to small and mid cap names can lead to high volatility. Investors must track such allocations.

If the fund manager focuses on quality stocks while building such concentrated portfolios, such schemes can outperform broad markets and other well-diversified pairs as well. In the recent downturn caused by the expectation of a massive economic slowdown caused by the COVID-induced blockade, most of the targeted equity funds managed to contain the downsides.

But that doesn’t mean that focused funds are a recipe for sure success. In case of misadventures of the fund manager or a fall in the general markets, focused funds could be severely punished. You must be prepared to obtain such extreme investment results from focused strategies. Investors should avoid overdoing it on focused equity funds. Invest in up to one of these schemes, ”says Rego.
“Funds focused with high allocation to quality stocks should offer higher returns than diversified capital schemes. However, only investors with a risk appetite should invest in these schemes, ”says Vinayak Savanur, founder and head of financial planning at MoneyMintingMantra.

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