Investors are increasingly gravitating towards focused funds, which boast a concentrated selection of high-quality stocks, in their quest for alpha generation. This trend is particularly notable in February, when net investments in focused funds surged while broader equity-oriented schemes faced declines, signaling a decisive shift towards prioritizing quality over quantity in investment strategies.

The Allure of Focused Funds

Focused funds differentiate themselves from diversified funds by concentrating investments in a select group of 20 to 30 stocks. These stocks are characterized by robust fundamentals, strong growth potential, and resilience amidst market fluctuations. This concentrated approach allows fund managers to achieve better risk-adjusted returns, enabling them to strategically allocate capital to sectors and companies that are poised for superior performance.

• February Insights:
  • A stark contrast emerged as all equity-oriented fund categories, except focused funds, experienced a decrease in net flows.
  • According to data from the Association of Mutual Funds in India, net inflows into equity-oriented schemes plummeted by 26% compared to January, while focused funds saw an impressive rise of 65%.

A Balanced Investment Approach

The uptick in investments in focused funds illustrates that investors are increasingly adopting a balanced strategy in the face of corrections in mid and small-cap stocks. Notably, these funds have demonstrated consistent performance, with the average returns for the top five focused funds standing at 17% over the past year and 19% over the last three years. Impressively, 80% of the 28 focused funds have outperformed their benchmark in the previous year, compared to 66% of the 39 flexi-cap funds.

Nirav Karkera, Head of Research at Fisdom, emphasizes that investors are gravitating towards actively managed, conviction-driven portfolios, particularly in uncertain times. “The momentum towards focused funds is expected to continue as investors seek avenues for alpha generation through insightful stock selection rather than mere diversification,” he explains.

Strategic Allocation in Focused Funds

One key advantage of focused funds is their flexible market cap allocation, which empowers fund managers to prioritize alpha generation while mitigating downside risks. These funds typically employ a bottom-up stock-picking strategy, capping their selection at 30 stocks. Currently, there is a noticeable trend among fund managers favoring high-conviction investment strategies that emphasize selective stock choices over broad diversification.

Recent data from Fisdom Research reveals a shift in portfolio allocation towards large-cap stocks, which have historically provided stability during turbulent market conditions. In February, exposure to large-cap stocks climbed to 73.5%, a significant increase from 64.8% in October 2024. Conversely, mid-cap stock allocation decreased to 14% from 22%, while small-cap stocks saw a slight dip to 12% from 13% during the same timeframe.

Fund managers are focusing on businesses that align with emerging market trends and exhibit resilience, steering clear of transient sectoral fads. The capability to adapt to upcoming economic changes will be essential for generating alpha. Nehal Mota, Co-founder and CEO of Finnovate, notes that recent corrections in mid and small-cap stocks have led fund managers to bolster high-conviction positions within these areas. “They are likely to explore new investment opportunities to enhance alpha generation, especially with the fresh inflows into focused funds,” she adds.

Considerations for Potential Investors

While focused funds can offer significant rewards, they come with a higher degree of risk due to their concentrated portfolios. Sachin Jain, Managing Partner at Scripbox, advises potential investors to assess their risk tolerance. “These funds are better suited for long-term investors who can endure short-term volatility,” he notes.

Before investing, it is crucial to evaluate:

• The fund’s historical performance
• The composition of its holdings
• The fund manager’s track record in delivering consistent returns across various market cycles

By being informed and strategic, investors can navigate the complexities of focused funds and potentially reap the benefits of this growing investment trend.