Hoping to do a Buffett

There are over 6,000 listed stocks in the Indian market. But how many of them are worth buying at any point in time? Well, a few Indian fund houses believe that 25 is a fair number.

Motilal Oswal Asset Management Company’s new fund — MOST Focussed 25 — plans to invest in not more than 25 companies at a time. Stocks will be selected for quality and business longevity, and held for long periods, in the hope that they will deliver market-beating returns.

This is Motilal Oswal’s first actively managed mutual fund. The fund house already manages five passive, index-tracking products — MOST Shares M50, MOST Midcap 100, MOST Nasdaq 100, MOST Goldshares and a 10-year gilt fund.

Features : MOST Focussed 25 is an open-end fund. It plans to hold a concentrated portfolio of 25 stocks with minimum exposure of 2.5 per cent to each. These companies will be selected for their earnings growth, free cash flows and shareholder returns; 65 per cent of the portfolio will be invested in the top 200 companies, 25 per cent in stocks above Rs 1,400-crore market cap and the rest, if necessary, in cash or debt.

Why focus on 25 stocks : Motilal Oswal argues that diversifying a portfolio beyond 25 securities produces no major benefit either in terms of reduced security risk or improving returns. It cites Warren Buffett, who believed in selecting quality companies with enduring ‘economic moats’ and sitting tight for the long term. Owning too many stocks, the fund house argues, shows lack of conviction.

The fund also provides numbers to show most Indian equity funds play it safe by holding over 50 stocks in their portfolio.

Pros and cons : The idea that a concentrated portfolio can deliver high returns is a sound one. By choosing just 25 stocks, a fund manager will be forced to seek out stock ideas on which he has high conviction. Given the dearth of quality stocks in the Indian market, this may also ensure better results for investors.

Motilal Oswal’s decision to apply Warren Buffett’s principles to this fund also makes it appropriate for a long-term investor. As a research house, Motilal Oswal also has good credentials to manage this fund, given its value/fundamentals-oriented approach.

On the flip side however, the idea of a concentrated fund isn’t new. There are already at least three diversified funds in the market — Sundaram Select Focus, ICICI Focussed Bluechip and Axis Focussed 25, which follow similar strategies.

Of these, the first two have a five-year track record, but haven’t fared significantly better than peers which follow a more diversified strategy.

Now, the key constraint to a concentrated portfolio strategy in India seems to be fund size and its impact on portfolio choices. Even equity funds which have started out with concentrated portfolios and succeeded in earning higher returns from this strategy have had to eventually diversify because of expanding asset size. The high impact costs in many of the smaller and mid-cap stocks in India make managers wary of building up very large positions in individual stocks.

MOST Focussed 25, if it succeeds may run up against this constraint too. The one key differentiator between MOST Focussed 25 and the existing focussed funds seems to be that it plans to own more mid-cap stocks, with nearly a third of the portfolio allocated to stocks smaller than the top 200. These may offer better returns, but with significant additional risk.

Overall, a concentrated portfolio strategy places great reliance on the fund manager’s skills. In short, a concentrated strategy may work quite well, provided one is a Warren Buffett.

Given that Motilal Oswal doesn’t yet manage any actively managed mutual funds, it is difficult to gauge its credentials on this score. It may be prudent for investors to bet on this fund once it demonstrates a consistent track record in beating the market.

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