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Are focused funds high on risk?

Dhirendra Kumar tells whether focused funds are riskier than multicap funds


 

Focused funds as a new category have the same mandate as of multicap funds, except the ceiling on number of stocks. They seem attractive but will they be high on risk because of the concentrated portfolio?
-Aparna Mehra

Yes. The risk comes in two forms. One is the likelihood of a fund manager losing money in a certain stock. I think if a fund manager goes wrong, the possibility of significant loss in a focused fund is far higher. Because in a focused fund a position in a stock can well be in the region of 5 to 10 percent.

The other is that focused funds can be far more volatile because you have fewer stocks. Nowadays, we are seeing a volatile market. So, the days on which the market goes down you see the concentrated fund falling much more than the market, compared to a more diversified fund.

I would say volatility is not as much of a risk on a 5 to 7 year basis. Because volatility, if you stay invested, is not a risk. But the risk of the fund manager going wrong is reasonably high.

So, yes, focus funds do come with high risk of volatility as well as the penalty for a fund manager going wrong with his selection is very high. And if he goes wrong with a couple of things, it could be a disaster.

But, I guess, that is where evaluation of a fund manager for a focused fund comes in handy. As a fund performs well and gets more money, it tends to become more diverse. So, I think 30 also gets you reasonable diversification.

So, check two things. You should look at the experience of the fund manager, of what he has set out to do and what are the quality filters. That apart, make sure even if it is a focused fund, it has at least 20 to 25 stocks, which is reasonable diversification for an investor. If you are comfortable with the volatility some of the focus funds look very promising.

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