What is Focused Fund - Benefits of Focused Fund, Taxation and How to Invest in Focused Funds?
While most investors prefer mutual funds for their diversification benefits, others tend to look for a focused approach to the stock selection strategies. While all the equity fund categories are defined with a clear investment objective, focused funds also carry an additional restriction regarding the number of stocks the portfolio can have.
What is a Focused fund?
As the name suggests, a focused fund is a type of equity fund that follows a focused investing approach. SEBI guidelines prescribe that a focused fund can have a maximum of 30 stocks in its investment portfolio, with at least 65% of its net assets invested in equities and equity-related instruments.
Such funds must clearly outline the focus area by the fund manager, e.g., multi-cap, small-cap, large-cap, specific sector/ theme, etc. As of 31st July 2020, focused funds have an AUM (Assets Under Management) of Rs. 0.51 lakh crores with 7% share amongst the open-ended equity funds
Source: Association of Mutual Funds in India – AMFI.
Benefits of Investing in Focused Fund
By investing in focused funds, the investors can benefit from a more concentrated approach to the stock selection. It mitigates the risk of over-diversification within the investment portfolio. When the fund has invested in a higher number of stocks, it may happen that all the investment securities do not perform at the same time.
While a fund manager of other categories may, by choice, keep the number of portfolio stocks lower, focused funds keep such numbers restricted as an investment philosophy. With a lower number of stocks in the investment portfolio, tracking the portfolio becomes much easier.
Additionally, the portfolio stocks are chosen after due research and analysis, focusing on keeping the number of stocks lower. As such, the fund managers take due cognizance of the stocks' growth potential to generate better returns for the investors.
How to Invest in Focused Funds?
The investment process to invest in focused funds is the same as investing in any other mutual fund scheme. Investors may physically apply at any of the official Point of Acceptance for mutual funds or invest online.
Taxation of Focused Funds
With a minimum of 65% investment in equities, focused funds are considered as equity-oriented funds for tax purposes. As such, the investors may classify the capital gains as Short-Term Capital Gains (STCG) and Long-Term Capital Gains (LTCG) based on a holding period of 12 months. If such a holding period is less than 12 months, the gains are considered STCG and taxed at 15% (plus applicable surcharge and Cess).
If the holding period is more extended, LTCG (post Rs. 1 lakh exemption every year) is taxed at 10% (plus applicable surcharge and Cess) without any benefit of indexation. The capital gains can be calculated by deducting the redemption value from the invested amount.
The investors may note that they may be exposed to relatively higher investment risk due to a concentrated approach, as the selected bets may not perform as expected. With fewer stocks in the portfolio, the probability of other portfolio securities mitigating the underperformance of one segment may be lower. Thus, such funds may be considered by investors who have a higher risk appetite.
Note: The tax provisions, as mentioned in the article, are for illustrative purposes only, and are updated as per the Finance Act 2020. The tax rates for capital gains will be as per the tax laws applicable on the date of redemption/ sale and not on the date of investment.