In September 2020, the Securities Exchange Board of India (SEBI) changed the guidelines for all Multicap funds in India. Read The new rules for multi-cap funds: How does this impact your funds for the details. This means that fund managers don’t have the flexibility to increase allocation to a particular market capitalization segment of stocks.
Many fund houses are considering moving out of the Multicap funds category for this reason. They are not willing to invest in mid and small cap stocks just to comply with SEBI guidelines. So, what can fund houses possibly do? They are most likely to convert their Multicap funds to focused funds.
What are focused funds?
These are mutual funds that invest in a small set of stocks or bonds that seem to have the same kind of theme or strategy. The fund will usually invest in less than 30 securities while other mutual funds might invest in 100 securities. Since they focus on a category of stocks or bonds, they are known as focused funds. The concept of focused funds is to invest in a number of quality companies to get good gains.
Note that these funds might concentrate on a particular segment such as large cap or mid cap. For focused funds, there are no restrictions for investing in a particular segment of the market. Fund managers choose segments that they think are of value. This is the reason why fund houses might choose to convert their Multicap funds to focused funds.
What should you do if your fund is converted to a focused fund?
You must understand that focused funds come with concentration risks because they invest in a lesser number of stocks. They won’t have diversified portfolios. This means by investing in the fund, you are taking risks. While that is said, the returns will be higher if the risks are higher. So, focused funds are ideal for those who want higher returns from their mutual funds and have a longer time to reach their goals.
Have focused funds really given good returns?
Let’s consider a few funds and compare them to Multicap funds. Axis Focused 25 is one of the most prominent funds in the Focused funds category. It has given more than 11% in the past 5 years. IIFL Focused Equity Fund has provided more than 11.9% in the past 5 years and the returns from the fund in the past 2 years is a good 17.5%. Most of the best Focused funds, on an average, have given an annualized return of more than 9% in the past few years.
Now, what about Multicap funds? Kotak Multicap Fund has provided investors with 9% in the past 5 years while HSBC Multicap Fund has given only 6.39%. Most Multicap funds have provided investors with average yearly returns of 7% in the past 5 years, which is much lower than the returns provided by Focused funds.
What are the advantages of focused funds?
These funds come with quality portfolios. Why? This is because the fund manager does a lot of extensive research on the stocks before investing in them. There will be minimal errors and the stock portfolio can be easily managed, that is, trading will be much quicker. It is easy to oversee the stocks and make decisions. This is an advantage for the fund manager. Stocks from across market capitalization can be chosen based on the value they provide. This results in higher alpha for the fund manager and better returns for the investor.
What are the tax implications of investing in focused funds?
These funds are equity-oriented funds. Therefore, your Long-Term Capital Gains (LTCG) will be 10% if the gains are more than Rs. 1 lakh. This is if you had held the stocks for more than a year. For Short Term Capital Gains (STCG), the tax rate will be 15%.
Note that when you choose focused funds, it is important to consider the expertise of the fund manager. The fund is only as good as its manager, especially for these funds. So, you need to do a bit of fund research before investing in focused funds. If you need any help, get in touch with your consultant at wealthzi.com.