Here’s a new way to invest in equities directly

About a year ago, as part of the reclassification of mutual fund categories, Securities and Exchange Board of India (Sebi) introduced focused funds, which invest in a portfolio of not more than 30 stocks. 

Several fund houses launched their focused funds, with Mirae Asset Mutual Fund being the latest. The other funds with a similar approach have given returns ranging between 19% and 20% over a five-year period. Read on to know how this category of equity funds work and if they are suitable for you.

What are focused funds?

Gaurav Misra, senior fund manager, Mirae Asset Mutual Fund, says, “This fund is for investors who are familiar with equities. It’s for an evolved investors. It’s a multi-cap fund and will invest in a portfolio of 30 stocks that will be diversified across the large, mid and small-cap segments of the market and also across sectors and themes. It will be spread out across 10 sectors.”

While focused funds might be a relatively new offering in the Indian financial ecosystem, equity mutual schemes have been around for a while. Equity mutual funds invest primarily in the stock markets with an aim to generate higher returns. These are actively managed by fund managers based on sectors, themes, market capitalisation (large, small, mid), to name a few.

Another type of equity fund that follows a similar approach is the equity index fund. It follows a particular index, for instance, Nifty. These passively-managed funds invest in the same companies, in the exact same proportions, making up the index the fund follows.

Mutual fund or direct equity?

But is MF the only route for investors to invest in equities? Can one make good returns by having a concentrated equity portfolio of good stocks similar to focused funds? Will it help save additional fund management charges?

Anant Ladha, founder of Invest Aaj For Kal and research head at Pankajladha.com, says, “The real question isn’t if a lay investor can make good returns in direct equity investing. The real question is if the retail investor can emotionally handle direct equity investing and maintain a long-term view while facing all the volatility of the stock market.”

The same was reinstated by Ashish Shanker, head, investment advisory, Motilal Oswal Private Wealth Management. Shanker says, “Direct equity route is a full-time activity. Retail investors may get temperamentally swayed away by the rapid volatility of the market. It’s a tough game for them as they will be competing with experts, like institutional investors out there.”

Direct investing involves research and time. But what if someone is willing to go the direct equity route, understanding that he or she might have to stomach the volatility? Shanker says, “In such a case, they should broadly keep three things in mind. First, choose good companies. You will have to understand the numbers. The data is easily available online. Know the Return on Equity (ROS), Return on Capital Employed (ROCE). An ROE level of above 15% is a good starting point.”

In fact, famed investor Warren Buffett has a simple rule to identify a good stock - one that has a healthy ROE level of above 15% and a ROCE level hovering around the ROE level and not too far.

Second thing, according to Shanker, is to check is if the company has consistently done well, and not just performed in the past one or two years. Also, analyse the business to see if it has the potential to survive the next 20-25 years. After all, equity is a long-term asset and gives better returns over the long term. Look at the indices and you will see that equity has emerged as an asset class that has outperformed all other asset classes over a longer period, in terms of percentage return. Again, all the data is available online.

Shanker says, “Identity your core competency. Which means, buy a company you understand. For instance, a retail investor will understand a consumer business a whole lot better than the steel sector. Look around in the real world and consumer businesses are easy to understand and research. For instance, in your office, you will see a majority of people will have a car from the same company.”

Another thing to remember is that if you work in a particular sector and understand that sector well, you might be able to identify better companies. For instance, if you work in IT or pharma, you will be able to analyse good companies and the business better.

Shanker says, “And finally, one can go via the “Coffee Can” investing (CCI) route, which is a buy-and-forget approach to investing in shares of companies which have performed well consistently.”

Again, many like author Saurabh Mukherjea in his book Unusual Billionaires define CCI companies which have generated ROCE over 15% every year and revenue growth of more than 10% every year, over the last 10 years. Only eight to twelve companies will fall in this list.

There’s no doubt that investing directly in stocks will need you to put in the hard work and research, which ideally your fund house would do if you had gone the MF route.

Manish Goel, founder director of equity research firm Research and Ranking, says, “There’s nothing wrong in going via equity MF. But if you are looking for higher returns or if you want to invest for wealth creation, then 10-12 good quality businesses, picked on solid research, specifically personalised for you, as per your financial goals, is the answer.”

Of course, there are a number of options out there for seeking guidance on investing into equities directly - brokers, financial advisors, media, stock tips by experts on social media, to name a few. There’s no doubt that there have been people who have invested in direct stocks directly and made more money that those who invested in equity mutual funds and index funds. The opposite is also true.

Rather than focusing on the numbers here, the most important thing to ask yourself is if you want to delegate the hard work to a fund manager or an equity advisor or would you like to get your hands dirty. If you choose the latter, remember to invest only a small part of your entire portfolio into direct equity, as you learn the rules of the game.