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Banking sector funds as a category topped the performance charts in the past three months with 23.62% return. But the same category of funds is the worst performer if you look at the one-year performance – the category lost 14.58% during the period. The story is same with infrastructure funds, too: they have gained 15.32% in the past three months, but lost 12.75% over the past one year. Similarly, most sectoral funds with higher exposure to the power sector have outperformed other funds by a wide margin in the last quarter of 2007 (calendar year), but they lost heavily in the first quarter of CY2008, as the market corrected. As you can see, the data — sourced from Value Research, a mutual fund tracking firm — presents a confusing picture. Especially for investors who are in search of sectoral funds to beat the broader market. But that is the hallmark of sectoral funds, which can be cyclical or extremely sensitive to even a minute change in their respective business environment.
Rationale
Alpha – the extra returns over the overall market returns – is a dream for many investors. And sector dedicated funds sometime do deliver on this count. According to Morningstar India, another mutual fund tracking firm, if you had invested in FMCG funds, you would have earned an average 10.57% return in CY2011. On the other hand, if you had invested in large-cap oriented equity schemes, you would have lost 24.46% during the same period. A look at the accompanying table will tell you that sectoral funds have occupied slots for top three performing ranks in the past seven years, except for a stray year of CY2009, when small- and mid-cap diversified funds as a category occupied the second rank with 95.36% returns. In short, if you expect a sector to grow faster than the economy, you can consider investing in a fund dedicated to the sector. Banking sector should benefit from the secular growth of the Indian economy in the long term, while recent the Budget provisions should be beneficial for the infrastructure and power sectors. Investors can consider investing in funds dedicated to these sectors.
However, a higher return is not the only reason why investors should look at a sector fund. A sector fund can be used sparingly in times of volatile market conditions to make your portfolio defensive. You can invest in a healthcare fund or an FMCG fund for this purpose, an investment advisory and training portal. FMCG and healthcare funds as a category have shown lower volatility over the long term compared to diversified equity funds. Over five years, healthcare funds and FMCG funds have recorded lower standard deviation of 27.63 and 22.14, respectively; compared to large cap funds (29.78) and mid- & small-cap funds (32.49).
Be Mindful About The Risks
A sector fund leaves the fund manager with limited options, as he has a mandate to invest only within the sector. If the sector enters a bad phase, the fund manager can do very little. A look at the performance of these schemes (See Table) also underlines the fact that you cannot simply invest in the 'best performing sector fund' of last year and sit quietly for it to deliver. To your surprise, you may find that the same sector is not in the top league anymore. That is why it is extremely important that you should have a clear view of the sector. Also, never invest too much in a sector fund as it increases risk. For example, if a professional employed in an information technology firm, with stock options of his company, invests in a technology sector fund thinking that it is a high growth sector, he may be sitting on a huge risk. Here most of his cash flows, fortune and investment are tied to the future of IT sector and any adverse development in that sector can have a devastating impact on his finances. If you are convinced with the growth prospects of a sector, you can invest in that sector's funds; but restrict your exposure to these funds to 10-15% of your equity portfolio.
How To Choose One
Short-term performance may give a distorted picture to investors due to high volatility, especially in the case of sectoral funds, where the stock universe is rather small. Always look at the long-term performance, say, more than three years, to arrive at an informed decision. Long-term track record is just one parameter to start with. Another important factor you have to look at is the portfolio composition. If you are considering a healthcare fund while building a defensive portfolio, a high MNC exposure may be better than a fund portfolio comprising Indian mid and small-cap companies during volatile market conditions. If you are in a volatile market such as the one we are in now, probably a large-cap oriented sector fund may be better to start with.
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