Focused Funds — What a Smaller Portfolio Actually Changes

Only the count. A focused scheme states a maximum number of companies it will hold and must say so in its documents.

What it does not restrict is where those companies come from. A focused scheme may hold large, mid or small companies, or a mixture, depending on its stated mandate, which our page on large, mid and small cap funds explains. So two focused schemes can be entirely different animals.

That is the first thing to check. The word focused in the name tells you about concentration, not about risk level, and reading the actual holdings is the only way to know which segment you are actually in.

A diversified scheme holding sixty companies dilutes everything. One holding doing badly is absorbed, and one doing exceptionally well is also absorbed.

Reduce that to twenty-five and both effects amplify. A position that goes wrong shows up in your value in a way it would not elsewhere, and a position that works is visible too. The distribution of possible outcomes is simply wider.

That is neither good nor bad in itself and it is frequently sold as though it were only the upside half. The honest statement is that you have accepted a wider range in exchange for the possibility of the better end of it, and nobody knows in advance which end arrives.

People treat these as the same kind of concentrated bet and they are not.

A sector scheme is concentrated in one part of the economy, so everything it holds is exposed to the same conditions at the same time, as our page on sectoral and thematic funds sets out. When that sector has a poor stretch, there is nowhere in the scheme to hide.

A focused scheme holds few companies but may spread them across sectors. The concentration is in the number of decisions rather than in a single part of the economy. That is a meaningfully different risk, and generally a less extreme one.

Whether a particular focused scheme has actually spread across sectors is checkable on the fact sheet, and some have not.

In a scheme holding sixty companies, no single selection decides much. In one holding twenty-five, several of them do.

So the result is more directly attributable to the judgement of whoever is choosing, which cuts both ways and makes a change of manager more consequential than it would be elsewhere. Our page on the fund manager covers what to check and how much weight to give it.

It also means the record of a focused scheme belongs more to a person and less to a process. That is worth knowing before treating several years of history as a property of the scheme itself.

As part of an equity allocation, sized so a poor outcome is disappointing rather than damaging.

What we would question is a household holding a focused scheme as its main equity exposure, particularly a first-time investor. The wider range of outcomes is precisely what a new investor is least prepared for, and an uncomfortable first three years is how people conclude that equity is not for them.

There is also a case for holding one alongside a broad scheme rather than instead of it. Check the overlap before assuming that works, though, since a focused scheme concentrated in large companies may be holding the same names your diversified scheme already leads with, which our page on portfolio overlap covers.

There is one combination worth looking at specifically, because the two constraints work against each other.

A focused scheme holding smaller companies, with a large amount of money to deploy, is operating under two limits at once. It may hold only so many companies, and each position in a smaller company can only be built so far before the buying itself starts moving the price.

What tends to happen is drift. The scheme holds larger companies than its description implies, because those are the ones that can absorb the money, and the investor ends up with something other than what they thought they bought. Our page on fund size and AUM covers why that pressure exists.

It is checkable rather than theoretical. Look at the current holdings against the stated mandate, and at whether the mix has shifted over the last few years as the scheme grew.

Four checks, and the first is the one people skip.

• What does it actually hold, and across how many sectors?
• Is your horizon long, since concentration needs more time to work, not less?
• How would a poor two years affect you, both financially and in whether you keep holding?
• Who runs it, and how much of the record belongs to that person?

We are distributors rather than investment advisers and we recommend no schemes on this site. If you want to work out whether concentration belongs in your plan, and at what size, get in touch, and how to choose a mutual fund sets out the order of decisions.