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Hocus Pocus: FOCUS Funds

Date : 16/04/2009

Author:  Babu Mathews

"Wide diversification is only required when investors do not understand what they are doing." -Warren Buffett"Wide diversification is only required when investors do not understand what they are doing." -Warren Buffett

The reaction of Fund houses was the creation of Focus Funds that concentrate on a particular niche market, sector or strategy. To me, they represent the manager's best ideas in the prevailing market scenario. But are they any good?

While most mutual funds hold well over 40 stocks, the typical focus fund will hold 20 or fewer. This brings about the concentration risk. We could debate about whether concentration of risk improves returns, that could be the fodder for another blog issue (for those interested, you can drop me a comment for inputs).

Back to our focus; in short

  • There is no clear evidence that focused funds outperform diversified funds,
  • These funds have significantly higher return volatility and tracking error to benchmarks.
  • Focused funds hold larger cash positions. Cash acts as a drag on returns for equity funds.

On the flip side however a focused mandate offers:
  • Below average expense ratio,
  • Market beating performance (higher volatility expects higher returns)
  • Very low turnover since fewer stocks are traded and hence saving in brokerage commissions;
But implementing these fund strategies have higher costs; Even if managers of focused funds have better stock-picking ability, their funds might not perform better than diversified funds because of liquidity problems.

So do Focus funds really beat ‘di-worse-fied’ funds?
The only answer, of course, is given by our Risk Manager >> "It all depends…"

Educate me



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