Facts you must learn about focused funds

How do focused mutual funds work?

In a typical mutual fund scheme, where fund managers are free to invest in a diverse range of stocks, this can range between 50 and 100 stocks. On the other hand, focused funds have a more concentrated portfolio with fewer company shares, up to a maximum of 30 stocks. However, the SEBI makes no restrictions on the types of stocks in which fund houses can invest. The fund manager selects the stock after considering the risk and reward factors.

Points to keep in mind before investing in focused funds

Before you invest in this kind of mutual fund scheme, you must keep the following pointers in mind. 

• Investment horizon:

Focused funds hold fewer stocks. They are more volatile in response to market fluctuations. As a result, if you are investing for short-term goals, this may not be the best option due to the increased risk. Focused funds are recommended for investments lasting at least five years.

• Returns:

Focused funds have the potential to outperform diversified funds in terms of returns. If your fund manager selects stocks from a polarised market (select stocks), you can expect more aggressive returns.

• Cost:

Always consider the expense ratio before investing in this type of mutual fund scheme. The expense ratio is the amount you pay for the management of your funds. If your expense ratio is significantly higher, your profit margin may suffer.

Benefits of focused funds

Focused funds have numerous advantages. Among these are

• Higher returns:

Unlike diversified equity funds, which seek to minimise risk while providing returns, focused funds have the potential to provide aggressive returns. Under this scheme, investment is usually parked under select stocks that are generally high conviction bets.

• Diversification:

Fund managers in focused funds have the freedom to invest in stocks from various industries. Furthermore, your investment in this scheme is spread across companies of all sizes, whether small or large.

• Handpicked stocks:

Since these funds have a limited number of stocks in their portfolio, fund managers make a special effort to evaluate the risk and reward factors of various stocks. Moreover, they select the best based on their analysis.

Which types of investors should be considered while investing in focused funds?

If you fall into any of the following categories, you should consider investing in focused funds.

• Higher risk appetite:

As previously mentioned, focused funds invest in a limited number of companies. Since the portfolio is limited, investments are typically made in stocks that have a high return potential but also carry a slightly higher risk. Even if a few stocks underperform, you could face a significant loss.

• Vintage investors:

If you are new to investing and want to build wealth with a small amount of money, this may not be the best option for you. Focused funds are recommended for seasoned investors who understand various analytical factors influencing market movement and stock performance. Such investors can predict when the market will fall and then decide whether or not to stay invested.

• Long-term goals:

The stock market and mutual fund schemes are based on the principle that the longer the tenure, the lower the risk, and vice-versa. If you are investing to meet long-term goals or looking for high-return funds with at least a five-year investment horizon, a focused fund is an excellent choice.

What are the tax implications on the focused funds?

Focused funds are taxed in the same way as other equity-oriented funds. For example, if you invest in this mutual fund scheme and intend to redeem it after at least a year, your earnings will be classified as Long-Term Capital Gains (LTCG). Your returns will be taxed at a rate of 10% in this case. The preceding scenario is only applicable if the profit from the focused fund in the particular year does not exceed Rs 1 lakh. 

On the other hand, if you redeem your investment before the end of the twelve months, the gains will be classified as short-term capital gains. The applicable tax rate for such gains is 15%.

To conclude

Focused funds have their own set of advantages and disadvantages. If you are a seasoned investor looking to maximise your return and have a five-year investment horizon, you should consider investing in this mutual fund scheme. To learn more about the various focused funds available on the market, visit ICICI Direct and download our mutual fund app.