Arijit Sharma is not a new mutual fund (MF) investor, but, 2016 made him feel that he is a newbie. His top investment holdings in funds with large exposure to IT and pharma companies dragged down overall performance. In contrast, his office colleague Sandeep bet big on funds private sector banking stocks exposure and made lots of profit.
If you share a similar tale like Sharma, you are not alone. Funds with one or two big-hitters, like in a cricket team, need to get it right every time. If the star batsman is out, they lose the plot. In contrast, diversified equity funds have a low risk profile that is suited for investors who don’t want to take concentrated bets. Experts say that MF investors must know the pros and cons of both types of investment styles, and then decide.
Difference: Put simply, a mutual fund often is a like classroom full of different types of students. A concentrated mutual fund is a smaller class of students compared to a diversified fund. A concentrated fund can often have less than 30 stocks, with a few companies holding a large amount of exposure. This kind of structure will mean that if those companies or sectors are in favor, the appreciation could be sharp. There are many products in the market like Axis Focussed 25 Fund, Kotak Select Focus, DSP BlackRock Focus 25 and Motilal Oswal MOST Focused Midcap 30, that aim to limit their exposure to a small basket of stocks. On the contrary, a diversified equity fund can have 50-90 stocks.
Returns tracker: According to HDFC Securities retail research data, concentrated equity mutual funds have delivered mediocre returns (barring one or two schemes) over various time frames and relatively underperformed their counterparts of ‘equity diversified’ category. In a study, it was seen that funds which had a portfolio of 43-52 stocks and 53-87 stocks gave higher returns with lower risk, than those which had a portfolio of 31-42 stocks and 43-52 stocks.
“Benefits of funds using concentrated portfolio include focused approach, lower portfolio turnover as number of stocks are less and exposure per stock is higher, and more risk and probability of earning higher returns,” says HDFC Securities senior analyst Prashant Mehta. For diversified funds, risk control is much better, but returns can get sacrificed as well.
Many fund managers prefer a concentrated strategy if the corpus size of a fund is small, say between Rs 1,000 crore to Rs 3,000 crore.
“Diversification does not only mean a higher number of stocks in a fund portfolio. There are studies to show that the extent of diversification in a fund with more than 20 stocks is not really great. If risks stay the same even if you have 50 stocks in your portfolio, there is no point in such a diversification,” says Anjali Mehta, a financial consultant.
Go as you like: For investors who are comfortable with sectoral bets, there are always sectoral funds. But, some sectors do not have dedicated schemes, or the existing funds may not have the kind of companies you prefer. For instance, there are not too many media-sector focused funds in India, at present. Similarly, automobile-focused funds are not there even though passenger cars is a profitable business and with a great set of companies.
“So, in a case, an investor is sure they want to take exposure of select sectors, only then should they go for such funds. For an average investor, a diversified fund with a long track record is a good enough option,” says Vikram Mathur, a professional investor, who recently bought CPSE ETF to increase exposure to energy-related space.
What you should do: Despite higher volatility and risk levels, many investors and financial advisors often vouch for focus or concentrated funds. Anil Rastogi, who has been dabbling in funds for over a decade, says that newcomers should strictly stay away from concentrated portfolios. “Diversified funds are like a whole course meal, with starter, main course, and dessert.
For most new investors, a whole course meal is the order of the day. However, seasoned investors like me feel that focus on one or two sectors works better. I have worked in the chemicals and FMCG industry and so, I can understand those trends better. I usually allocate 25% of my money in focus funds if they are available for the selected theme,” Rastogi said.