The simplest explanation of a focus fund is one in which the manager invests the fund’s assets in a limited number of companies. The result is a fund that most likely will not behave like any broad index and if the manager is skilful – or lucky – one that will outperform its peers. Focus funds are relatively new but several now have a three-year tra
ck record which gives reason to take a closer look at how they have performed.
A search of Morningstar’s pan-European database identified 177 focus funds sold in the UK.* The table below outlines the Morningstar categories in which most of these funds were found.
| Category Breakdown | |
| Morningstar Category | Number of funds |
| UK Large Cap Equity | 27 |
| Asia ex Japan Equity | 18 |
| Central and Eastern Europe Equity | 12 |
| Europe ex-UK Equity | 11 |
| Tech. Media Telecom Sector Equity | 11 |
| Euro-Zone Large Cap Equity | 9 |
| North America Equity | 9 |
| UK Mid Cap Equity | 9 |
| Finance Sector Equity | 8 |
| Life Sciences Sector Equity | 8 |
| Other Morningstar Categories | 55 |
Source: Morningstar, August 2004
The UK Large Cap Equity category, which has the largest number of these funds, is one of the most important segments of the market for a UK-based investor. Therefore it provides an excellent opportunity to look closer at these funds and what they have to offer.
It is easy to understand why these focus funds have become popular over the last couple of years, both with fund management groups and with investors. With fund sales down after the crash of March 2000 and with index tracking funds and closet-trackers following the broad benchmarks down – or more recently trapped in a trading range – investors are looking for products that deliver performance. An added benefit for the investment management groups is, of course, that they can sell the fund as embodying the fund manager’s “best ideas”. While that might be the case, focus funds are more than just the latest trend promoted by the industry. Used correctly these funds can add value to an investor’s overall portfolio.
How have they performed?
Previous Morningstar research on focus funds in America has shown that it paid for diversified US domestic equity funds to build large positions in their top holdings. In these funds the diversification of the concentrated holdings among different sectors was key. On the other hand, the same research showed that sector-specific funds that emphasised their top holdings performed badly as the performance of their top holdings was often highly correlated.
A look at the 27 funds identified in the UK Equity Large Cap category reveals some of the characteristics of these funds. On average, these funds have 34 holdings compared with an average of 90 holdings for the whole category. The focus funds subset also has 47% of assets in their top ten holdings. Some 15 of the 27 funds were launched after March 2000 and it is clear that performance of focus funds usually falls near the top or near the bottom of the category.
Of the 18 funds with a three-year performance history five fall in the first quartile over the last three years, as of July 31st. Six are in the bottom quartile over the same time period. Only three funds fall in the 40-60 percentile range.
The average standard deviation for the focus funds with a three-year history is 15.7 – the same as the average of the whole category. The true risk is, of course, the fact that only some of these funds deliver the expected performance. The best performing fund, ISIS UK Prime, returned 12.56% over the past three years (as of July 31st) while the worst performing fund, GHC UK Equity, was down 26.25% over the same period.
Below is an overview of three focus funds that stand out from the 27 in the UK Equity Large Cap category. These funds are in the top 10% over both one and three years.
| Top Performing Focus Funds | ||||
| Fund Name | Return, Year to Date | Manager Name | % Rank in Category (1Yr) | % Rank in Category (3Yrs) |
| ISIS UK Prime Fund | 3.13% | Mike Felton | 4 | 2 |
| Rathbone Income & Growth Fund | 6.81% | Julian Chillingworth | 5 | 3 |
| Martin Currie IF UK Growth Fund | 3.29% | Jeff Saunders | 5 | 8 |
| UK Equity Large Cap Average | 0.06% | |||
Source: Morningstar, performance in GBP as of July 31st.
What to look for in a focus fund
One of the important features to look for in a focus fund is an experienced manager. This is a quality of the three funds listed above and is also confirmed by the research Morningstar has performed in the US.
Mike Felton, the manager of the ISIS UK Prime fund, has 15 years of experience and Jeff Saunders of Martin Currie had 17 years of experience in the UK market when he joined from Standard Life in 2000. Julian Chillingworth has some 22 years experience and has been the chief investment officer at Rathbone Unit Trust Management since August 2002.
An experienced manager is also what many IFAs are looking for in a focus fund. Patrick Connolly, an investment manager at John Scott & Partners, says that for him the most important features are “confidence in the fund manager as the performance is reliant on the manager’s stockpicking skills and understanding what the manager’s investment process is”.
He is currently investing in ISIS UK Prime, highlighted in the table above, as well as the Schroder UK Alpha Plus fund. The Schroder fund does not yet have a three-year track record but it certainly fits the description of having an experienced manager in Richard Buxton. While it showed excellent performance in 2003, beating the UK Equity Large Cap category average by 12 percentage points, it is lagging so far this year, another illustration of the fact that concentrated bets can work both for and against you.
Ben Yearsley, an investment manager at Hargreaves Lansdown, highlights similar features as important. “In these market conditions when the index is not going anywhere focus funds are one of the ways forward to make money over the medium and long term”. He mentions the Invesco Perpetual UK Aggressive fund as a personal favourite.
Robert Burdett, the joint head of multi-manager services at Credit Suisse Asset Management, says that “focus funds have given the ability to perform back to a generation of managers who were institutionalised to ‘index plus’ in the 90s.” Some of his favourites include the Martin Currie IF UK Growth Fund and Schroders’ range of alpha funds.
Mr Connolly at John Scott & Partners uses focus funds in client portfolios but not extensively. “We aim to control the risk of the portfolios and with a focus fund you don’t always know where the manager will be moving. We will put a core portfolio in place for the client and add focus funds around it.”
A focus fund that stands out
By broadening the scope and looking at the whole universe of funds one of the true success stories in picking winners in the concentrated fund game appears – Bill Miller at Legg Mason.
In a search for equity funds sold in the UK, across all categories, with less than 40 holdings and with top quartile performance in its category each calendar year since 1999 only one fund appears – the Dublin-domiciled Legg Mason Value fund, managed by Mr Miller since inception. It is in the top decile over five years and top quartile over three years. This year has not been as strong though, with performance lagging its peers in the North America Equity category by 2.3 percentage points as of August 30th.
A lesson from Warren Buffett
While some focus fund managers have been successful in producing value for investors others sit in the bottom of their categories. A limited number of holdings increases the possibility of ending up with performance that is either much better or much worse than the average. It would, however, be simplistic to say that all focus funds are risky as it is not necessarily the number of holdings that contributes to the risk.
Haywood Kelly, the chief of securities analysis at Morningstar in Chicago, recently wrote a story discussing the equity portfolio of Berkshire Hathaway, the holding company run by Warren Buffett, one of the all-time great investors. With regards to holding a focused portfolio Mr Kelly wrote:
“Buffett has never been a fan of spreading his bets. Diversification may reduce volatility, but it doesn't necessarily reduce risk. The two concepts are often confused. Volatility can actually help reduce risk because it allows more opportunities for a savvy investor like Buffett to load up on an asset when prices are attractive. Buffett argues that the best way to reduce risk is to focus on companies you know extremely well and companies that boast strong competitive positions. If their earnings or share price happen to bounce around a lot in the short term, who cares?”
To be successful, investors must, of course, understand how a focus fund fits within the overall portfolio. Yet, one of the main difficulties and risks of investing in focus funds is finding a manager that is able to put together a concentrated portfolio of winners rather than losers over the long term.
* The definition for this search was the oldest share class of funds registered for sale in the UK, investing at least 80% of assets in equities, with 40 equity holdings or less, based on the latest portfolio made available to Morningstar. Funds with portfolios older than January 2004 were excluded. Fund of funds and index funds were also removed.
** The 27 Stocks in the Buffett Portfolio, (www.morningstar.com)
This article originally appeared in the October 11th issue of Investment Adviser.
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