Concentrated funds are a good bet if you have appetite for risk

For the risk averse, buying diversified funds with more stocks might make more sense

The Securities and Exchange Board of India (Sebi) has expressed concern at the high concentration of a few stocks in bank exchange-traded funds (ETFs). But it is not just bank ETFs. A number of diversified equity funds might face the risk of high concentration.

Equity funds (excluding equity-linked savings schemes and sector-thematic funds) can be categorised as concentrated or diversified in accordance with the number of stocks they hold and the level of exposure they have to select sectors and select stocks within their portfolio. In concentrated funds, the fund manager holds fewer stocks, usually 15-20, going up to 25. Diversified funds hold a higher number of stocks: More than 25 and going up to 87 (among equity funds in India).

The top three sectors’ concentration in funds ranges from 9 per cent to as high as 63.44 per cent (the median, which is the central figure in a distribution, is 32.49 per cent). The top three stocks’ concentration ranges from 3.79 per cent to 29.42 per cent (the median is 16.45 per cent).

Concentrated funds are a high-risk, high-return bet. “If the fund manager’s stock picks work out well, these funds allow you to earn much higher returns compared to the benchmark,” says Taher Badshah, chief investment officer, Invesco Asset Management India. He manages Invesco India Dynamic Equity, which holds 19 stocks. The flip side of these funds is that a couple of large bets made on the wrong stocks can pull portfolio returns down rapidly. These funds also tend to be more volatile. “Their performance can deviate significantly from the benchmark over shorter durations,” says Badshah. Concentrated funds are suited for investors who have a higher risk tolerance.

Diversified funds, which tend to be less volatile, are better-suited for first-time investors and those with a low risk appetite. “Many investors become scared by high volatility. In Principal Emerging Bluechip Fund, we have spread our bets, especially in the bottom 10 per cent of the portfolio, so that our investors experience less volatile performance,” says PVK Mohan, head of equities, Principal Mutual Fund.

“The fund manager's stock-picking skills are of paramount significance in these funds,” says Kaustubh Belapurkar, head-manager research, Morningstar Investment Advisors. Check the fund manager’s track record in managing a fund with such a strategy. Also, ensure that the fund does not have very high exposure to just two or three sectors.