Before you start reading about sector fund – I would like to tell you clearly that this is the riskiest category in mutual fund. Time to time few of the sectors have given phenomenal returns but end of the day losers are more than winners when we talk about investors. My suggestion is they should never be part of your core portfolio but depending on the individual you may think about this in your satellite portfolio. In this article I have covered what are sector fund, best sector funds, benefits & risk associated with them and finally should you invest in sector fund.
First understand what diversified equity mutual funds are. Diversified funds are the funds which don’t have any restriction on particular theme or sector. Or we can say diversified funds invest in different sectors like banking, information technology, pharma, power, FMCG etc. If I talk about Indian stock market it is divided into 56 broad sectors. So if you want to take advantage of entire market, you would look for a fund which is democratic when it comes to choosing a stock for the portfolio.
Read – DSP Health Care Fund Review
Now a classic example from a foodie. Once I was on a training to Hyderabad, and before going I was very happy as I thought I will eat only Biryani, which I was really fond of. Moment I landed in Hyderabad, I started my expedition of eating Biryani’s. I tasted Biryani at all places including the gali behind Char Minar and the thela outside the Salarjung. Although the training was supposed to be for 10 days, I had to rush back home on the 8th day as I was sick and my throat caught an infection as I was eating too much of spices. Was I wrong? I was a Biryani lover and now if it is served in a buffet, I feel vomiting.
What is Sector Fund?
So now without even writing what are sector funds you must have guessed what these are? Sector funds are those funds which invest in particular one sector. Like funds dedicated to Information Technology or Banking. There is very low diversification as they are taking concentrated bets on a single sector or 2-3 main sectors.
Best sector funds
This is list of top 10 equity funds of last 3 years – total equity funds 383. (25th May 2011) You can clearly see 7 funds out of 10 are sector fund or theme fund.
So should we read more about it? Yes.
Benefit of investing with sector funds
If you are sitting in the right sector & that particular sector performs – your fund will substantially rise. This will give boost to your overall investment. Take example of Reliance Diversified Power Sector Fund – if you invested in 2004-06, it would have given additional return of 1-2% to your investment portfolio. Check comparison graph between Reliance Diversified Power Sector Fund & Sensex.
Risk associated with sector fund
The vice versa of the above mentioned benefit is also there. The benefit of higher return turns into risk if you are sitting in wrong sector & at the wrong time. There can be substantial losses which will pull back your portfolio. So, if your agent sold you an IT Fund in 2000 or Infrastructure related funds in 2008, probably you also had your “Biryani” as they have underperformed in comparison to the broader markets. (Check image on left) One of my friends when approached me was sitting in Reliance Natural Resource Fund(Red) – we suggested him to move in Reliance Pharma(blue) & green line is Sensex. You can see how wrong selection of sector can have adverse impact on the portfolio. From Friends Account Statement.
Can we learn from what happened with IT sector funds in 2000
None of my investors invested in IT sector fund 🙂 because I was not part of investment world at that time. But I was there to face aftershocks of IT earthquake & learn from them. Every second investor I met that time was having more than 40-50% of their total funds in IT related funds – even diversified funds were heavy on IT sector ranging from 20% to even 50%-60%in some cases. Few of the IT sector funds were having 4-5 funds on name of diversification – even few diversified funds were having exposure of 20-30% in a single IT stock. 🙁 NAV were drifting down from Rs 10 to Rs 2 – investors were not ready to sell at that price. Investors burnt their hands, legs, clothes, homes & few of them swear that they will never return to equity markets. AMCs were facing lot of pressure – few changed name of their funds, few investment objectives & few others hided those funds by merging. But loss was done & their was nothing other than lessons to learn. Picture will tell the full story
Sector Fund Vs Theme Fund
Theme Funds are not 100% diversified but include particular set of sectors. As infrastructure theme includes construction sector, banking sector, energy sector, power sector etc. If we talk about rural theme it will cover Fertilizers, FMCG, Chemicals etc.
Why I am writing about sector mutual fund now
2-3 instances happened recently which forced me to write on sector funds.
- Lot of people started asking us about “Silver Funds” or “Natural Gas Funds”. The biggest mistake our retail investors do is they try to catch train at the last moment. And in the end you only get to land in the Guards Cabin or the Luggage Room. The markets have already discounted the price of these assets (Silver, NG etc) but we want to invest in them NOW. When smart people are booking profits (and the non-smarts are still carrying their short contracts) the retail person wants to taste a new avenue. This is not directly related to sector funds but shows how people attract to fancy of the market.
- Recently one of our new clients asked for investment in some Pharma based fund & we said no, but actually few of our clients have exposure to it.
- I have done a case study for Business Bhaskar where this guy was having exposure to some Banking fund & I said to redeem it. I got a furious call on the same day “Why you advised him to redeem Banking Fund – you nuts don’t you know it’s among the best performing funds & if India will grow banking sector will get benefited.” I just laughed & kept the phone down.
Should you invest in Sector Fund?
Nothing is good or bad but how we use it makes the difference. Guns are used by army as well as terrorist – nuclear energy is used for construction as well as destruction. So you should remember these points before buying sector funds:
- For a new investor who have not seen 2-3 market cycles, the answer is NO Or should take prescription from Financial Doctor. (Financial Advisor)
- You should not invest in those sectors which are already heavy in your portfolio. If you talk about banking, it’s already 20-25% in every diversified equity fund – so when you add banking sector fund you are increasing risk.
- You can add a sector fund when you are sure about growth of particular sector but your portfolio is lacking it. In other language you are trying to be smarter than fund managers but we know it is not always possible. But we as an advisor introduced Reliance Pharma Fund to our clients when we thought there was nothing to lose & it paid well. At that time total exposure of Pharma sector in diversified equity funds & index was less than 3-4% – so we think we have not increased the risk but given some more diversification to portfolio. (In image you can again see comparison between Reliance Pharma Vs Sensex. From my sister’s portfolio.)
- If you follow Shariah Rules or you would like to avoid particular stock for any other reason – you can construct your equity portfolio with sector funds.
- Sector Funds Vs Direct Stocks: If you have understood that you have to invest in particular sector you have 2 choices – either you go through direct route & buy 2-3 equity stocks or go through mutual funds. Now here comes benefit of diversification – yes diversification in stocks in that particular sector. Fund manager will be holding 10-12 good researched stocks in a sector fund – so you can take benefit of it. So if you are very sure of just 2-3 companies you should go directly to bourses but this surety would only come if you have researched the stock well. If you have not but still feel bullish on a particular sector or theme mutual fund is your way out.
In Financial Planning, there are 2 school of thoughts, one which says that investor should invest a part of its portfolio in Sector Specific assets considering his risk appetite and the other thought says that one should stick to Diversified Funds as these fund will themselves tilt the portfolio towards a sector which is showing a potential of beating the broad markets. So I leave this to you to take a call.
How many sector funds one should have?
Sector funds work like Chris Gayle & Yousuf Pathan – when they perform you easily achieve the winning totals but when they don’t perform you should not feel sorry. One thing is clear we should have a balanced team & we can’t have 11 Gayles on one side. Know your limit while adding sector fund.
Disclaimer: I can be biased towards particular fund, sector or theme because they may be part of our client’s portfolio. Few of our clients have 5-10% exposure to Reliance Pharma Fund depending on their portfolio requirement & risk appetite. We have shared statements after taking permission from the clients. Credit: data used & graph made are with the help of tools available with mutual funds India & value research
Have you ever invested in sector or theme funds? What was your experience?