Diversified equity mutual funds offer investors varied styles of investing. There are value-style funds, growth-style funds, some follow a mix of both value and growth (known as blend funds), some take a contrarian approach, and then there some which display proclivity (led by their investment mandate) to a market-capitalisation – large-cap, mid-cap, small-cap, micro-cap, multi-cap and so on. Besides, there are sector/thematic funds as well.
However, there is one lesser-known category of funds (despite over a decade-old track record) where the fund manager is on the constant lookout for sectors that can benefit due to changes in the micro and/or macro environment. Here the fund manager seeks to take advantage of wealth creating opportunities arising out of changes in Government policies, industry specific regulations, trade agreements, among a host of other factors, and is even (facilitated by the investment mandate) to flexibly move the portfolio across promising market capitalisation. This category of diversified equity schemes is known as ‘Opportunities Funds’.
Currently, only 11 schemes continue to exist in this category. Fund houses seem to have lost interest in launching more of such schemes. This in itself speaks a lot about the performance of opportunities funds—where returns can be inconsistent and can carry a significant amount of risk.
Let’s take a quick look at the five attributes of Opportunities Funds….
- Flexibility to invest across market-caps
Unlike other diversified equity schemes that maintain a market-cap bias, such as large-cap or mid-cap funds; Opportunities Funds do not show a market-cap bias. They sight promising opportunities, invest across market capitalisation, and are quite flexible in their approach.
So, if a scheme invests predominantly in large-caps, it should not be taken for granted that returns will be stable and volatility would be low; because the fund manager depending on market opportunities could alter the portfolio. Hence, though the flexibility of Opportunities Funds gives a sense of diversification, as an investor you should remain cautious and invest prudently.
- Concentrated bets
While sighting opportunities, these funds tend to hold a concentrated portfolio for a period of time. Opportunities Funds invest in stocks of 4-5 sectors that are expected to outperform the broader market over the short-to-medium term.
The portfolio is constructed based on the fund manager’s views on the macro economy with a specific focus on the micro impact of economic reforms, restructuring and mergers & acquisition activity. Therefore, such schemes may invest in specific sectors/themes that are expected to benefit from the changing trends and the fund manager’s view thereon.
For example, if the infrastructure sector receives a boost from the Government, the scheme may tilt its portfolio to stocks from this sector, taking cognisance of the fundamentals. So, it’s often conviction driven, and hence, as an investor you could be subject to considerable risk.
Top-weighted Portfolios, Concentrated Bets
Portfolio data as on January 31, 2017
(Source: ACE MF, PersonalFN Research)
As seen in the table above, the top-10 stocks account for over 1/3rd of the portfolio of most schemes. For schemes such as HDFC Core & Satellite Fund and HSBC India Opportunities Fund the top-10 stocks account for over half the portfolio weightage. In most cases, the top-2 sectors account for over 1/4th of the portfolio.
- High risk-high return proposition
Opportunities Funds as a category are a high risk-high return investment proposition. In an extremely volatile market environment, there is scope to find investment opportunities. However, the risk too, is greater. If reforms or regulatory policies do not favour a particular sector/theme and/or stock therefrom going ahead; it may lead to deterioration in performance of a fund.
High Risk, High Return
Data as on February 21, 2017
Risk is measured by Standard Deviation and Sharpe Ratio measures Risk-Adjusted Return. They are calculated over 3-Yr period assuming a risk-free rate of 7.38% p.a.
(Source: ACE MF, PersonalFN Research)
The returns of Opportunities Funds can be capricious, while they endeavour to clock alpha. Nonetheless, by taking calculated risk, certain schemes are able to deliver better returns. But it is important to note, that this may not always be the case. Therefore, it is important to consider the risk-adjusted returns as well, which are measured by the Sharpe Ratio.
- High portfolio turnover
As the fund manager is constantly on the lookout for stocks that can add value over the short-to medium-term, the turnover of opportunity funds is usually high.
Be Wary Of High Churn
Data as on January 31, 2017
Average portfolio turnover ratio of the past three months
(Source: ACE MF, PersonalFN Research)
If he comes across a stock ideas that are expected to do well, he would switch from investments, which have failed to pay-off, or those where the growth has been maximised for a new investment. This is a constant process and if a fund manager is able to get more rights than wrongs, the opportunity fund would do well.
- Fund manager experience is crucial
The performance of an Opportunities Fund is mainly dependent on the fund manager’s ability to identify rewarding opportunities. A fund manager not only needs to have sound knowledge and understanding of how businesses within each sector/theme, but also needs to have a good judgement of how changes in policies etc. would affect these businesses or sectors/theme. This skill develops with years of experience. Only a few may be successful. And at times, even ace fund managers can be proved wrong by the market.
There is a possibility that the funds may go through bouts of underperformance as seen for a few schemes in the past. However, if the management maintains its focus on delivering high returns, despite the risk, the scheme may stand to gain from a significant upside when the markets move back up. As an investor, you need to be patient when returns don’t come easily, and focus on the long term when investing in an opportunity fund. Performance among schemes can be inconsistent
Yearly Absolute Returns
(Source: ACE MF, PersonalFN Research) Who should opt for an opportunities fund?
If you are investor seeking that extra return and do not mind the short-term volatility, then opportunity funds are for you.
As we mentioned earlier, the fund manager needs to be precise when making a judgement of how reforms and policies will benefit sectors/themes. If a bet does not work as the fund manager expected, it might result in losses. Therefore, there needs to be sound risk management strategies in place.
It is vital to select Opportunities Funds that follow sound investment processes and systems.
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