Choosing a right Sectoral Fund

It begin with, equity mutual funds can be classified as active and passive. They can also be classified on the basis of value, Growth – depending on whether they are looking for opportunities. There could even be an opportunity fund.

Thanks to the distributor led development of the mutual fund market; we have sought variety in our funds like we need variety and options in food! This is not to say that variety is bad, but does it make sense to have so much variety and options in such a hugely under educated market? Let us look at the sector funds – some people call them focused funds. These equity funds focus on a particular theme – like growth, value, mid-cap, and Dividend yield etc. sector funds as we know them concentrate on a particular sector like Pharmacy, Oil, Banking, Information Technology, and FMCG services and so on. The most famous cousin of them all – ‘Infrastructure’, Each and every fund houses has some ‘sectoral’ fund or the other. Even fund houses like HDFC and Templeton who were never attracted to ‘sectoral’ themes fell to ‘Infrastructure’ as a theme. One must hasten to add that Templeton’s earlier foray into ‘IT’, at the peak of the Technology boom was at the fag end of the Tech boom. Should there be sectoral funds at all? Does the small investor make money in a sectoral fund? Why do we have sectoral funds?

These questions are philosophical and frankly for the regulator to worry about. But we will look at this from the retail investor’s angle.

If one glances at the list of equity funds, one comes across many sector funds that invest in specific ‘sectors’ and ‘themes’. Investors are also keen to have a long list of mutual fund investments, make a killing in the market, watch for action and constantly keep looking out for ‘hot’ sectors. Funds houses are under the pressure of SEBI not to launch schemes which do not look like already existing schemes.

Distributors who sell mutual funds are keen to push NFOs to the above-mentioned clients. In this heady cocktail, it is easy to launch a sectoral fund – and push or market it as an emerging sector or a hot sector. So, welcome to sectoral funds from fund houses. These schemes are doing well as there is a demand for the stocks in these hot sectors.

To know how the sector funds work, one needs to know about the birth of the concept of sector funds. Equity markets as a rule go through bull runs and each time there is a bull run, the leader group changes. For example, if the equity markets have gone up 20% in the past one year – obviously some sectors would have gone up more than that and the others less than that. However, the bull-runs need not be across all sectors – there will be always some leaders and some laggards. This table is clear – even the person who invested in banking sector wishes he was in financial services rather than just in banking. This is the problem of the alpha-seeking investors. They may possibly view it as an opportunity to exit media and enter financial services. Of course, there will also be some savvy alpha-seeking investors who might be doing the reverse. Such investors who hope to beat the index, better known as alpha seekers, try to find out the sectors where they would achieve that alpha.

Such investors know that if they get the sector correct, they need not worry too much about getting the company correct. That is the fund manager’s job. This trend has led to the birth of the sector funds. Mutual funds normally chase ‘assets under management’. These alpha chasing investors want to invest in sector funds. When it comes to the launching of new schemes aimed at investing in ‘happening sectors’ some fund houses specialize in NFOs. Investors have made good returns in sectoral funds only if they know how to time the markets. A few well informed investors put money in a sector fund. The fund does well – and people rush into the scheme. This puts so much pressure on the fund manager that he finds it difficult to invest in that sector. When it comes to investing in sector funds, let it be mentioned that the market timing is difficult for the fund manager as well as the retail investor. The sector investing concept again, gathered momentum when it got included in the growth history. The sectors like ‘infrastructure’ and ‘lifestyle’ gained momentum. Investors enjoyed the rally in the infrastructure stocks for some time – and then saw a huge dip. Again, infrastructure seems to be the flavor.

Unfortunately, the time to be selling the infrastructure theme is perhaps the worst time for the find manager to be investing in infrastructure shares. When infrastructure funds are soaring in performance, the fund manager should be actually selling and closing down the fund. Sector funds invest in one sector or a gamut of companies supporting a theme. This is mentioned clearly in the offer document. The trustees and the fund managers ensure that the money will be employed in specific sectors only. However, some sectoral funds can be very wide in their areas – “companies that help in the creation of infrastructure and ancillary industries” is big enough to encompass banks, cement, steel, ship building, road making, and housing companies. If one narrows down the definition, the fund manager does not have enough choice.

As a rule, one can say that sectoral funds be bought, when it has just come off a poor run. For example, when everybody is investing in infrastructure funds, maybe one should be looking at an FMCG fund. A thumb rule is when everybody is pushing a sector fund towards the public- it is a good time to stay away from it. Gold, for example, has had a good run for the past few years. Is it a good time to be investing in a gold fund? There are as many answers for investing in a gold fund as there are for NOT investing in a gold fund. Surely, sectoral funds are riskier than regular diversified equity funds. Also, if a sector is really good, will the fund manager in this ‘diversified equity fund’ not pick enough shares of that sector too? So, what does it take to invest in them?

Sector funds should be used by investors who track sectors closely. For example, if there was a ‘Sugar’ fund, the time to buy it is when sugar is selling in the markets at $ 1. And one should be selling it when sugar is selling at $ 2. The same principle is applied to other commodities as well. However, the chances of finding an NFO when the sugar price is $ 1. All funds are set to do well in certain market cycles. If one chases past performances, one is likely to take a severe beating in the market. Another way of investing in a sectoral fund is to be happy with the returns that one has clocked. For this, one should have a pre determined limit and stick to that target. For example, if you wanted 40% return from a sectoral fund, come out if the fund gives you a 40% return. Even if the fund then goes on to clock 80% returns – it is beyond one set objective.

If one still wants to invest in a sectoral fund then keep the exposure down to about 15% of the equity allocation. If one has decided that she/he will be 70% in equities and sectoral fund will only be 10% of the total portfolio, then one is involved in two sectors.

One should buy sector funds based on the broader economic factors around the world and the country. Do a sectoral analysis of your existing portfolio for example if you are working the IT sector. Your portfolio consists of your own ESOP, Infosys, TCS, Wipro and some mutual funds. Those funds have also invested reasonable amounts of money in IT shares, for one investing in an IT or a TMT fund makes no sense at all. When one sector is soaring, it is prudent not to enter that sector. Some basic analysis of the portfolio also, like studying the price/earning ratio, price/book value ratio and price/sales ratio before one invests is a wise thing to do. A long term view should also be considered and be clear as to when one will sell. There needs to be either a time or a price limit or both the exercises should be implemented.

Are there some safe sectors? Should it be a part of my portfolio?

FMCG:it is like a sister business to Pharmaceuticals. FMCG is a defensive sector. So, the risk is not very high – however, the sector may not be cheap. Some shares like Pantaloon may look expensive, but one gets the benefit if an FMCG fund already owns Pantaloon.

POWER: all brokerages are going hoarse, telling people to buy power sector stocks, by revealing statistical information. Also NTPC, GAIL, Power Grid etc. are being flaunted as the next gold mine. So, if one is not sure about one’s stock picking skill, one should look at this sector.

Infrastructure sector: all governments in the world are pumping money into their economies which means interest rates are likely to be low. The governments also, all around the world, want to spend money on infrastructure, so the infra looks good. However, it may be a little late to be picking up an infrastructure fund.

The sector looks positive with only a long term perspective. Clearly two sectors to avoid are the Auto and Banking sectors. If we glance at the above statistical table, we realize that these were the same sectors which have given a fantastic out performance vis-à-vis the index. Staying away from these funds may appear foolish in the very term, but sensible in the slightly medium term. In the long run, one may just have beaten the Sensex by a small margin. The risk is you may buy the IT sector because all the companies in the sector are doing well – but lose your shirt in the adverse movement of the dollar! Best of luck!