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Sector Funds: Limited Menu

Author: Vishesh R Sharma/Friday, April 3, 2015/Categories: Mutual Funds

Sector Funds: Limited Menu

As the Central Government has been harping on increased focus on specific sectors, the concept of sector funds has gained prominence once again. These funds present attractive options for investors who are keen on specific sectors or companies and wish to capitalise on those. While providing the opportunity to secure better returns, these funds also come with ‘high risk’ rider, and should make up a limited part of the portfolio.

Sector funds, as the name suggests, invest in particular sectors. The basic idea of a sector fund is to enable investors to take advantage of industry cycles. They have the potential to offer attractive returns if the timing is right. However, they do not provide the downside risk protection available in diversified funds. Thematic funds look for trends that are likely to result in the outperformance of certain sectors or companies. In other words, the key factors for these funds are those that can make a difference to business profitability and market values. Thematic funds focus on structural as well as cyclical factors that play an important role in the economy. 

Who Can Invest

Sector funds can be an ideal option for investors who understand a sector as well as its future potential, and seek diversification within that sector. Besides, these funds can play a supporting role in a diversified portfolio by allowing investors to increase exposure to sectors that may be under-represented in their portfolio.

For those who invest in stocks directly, sector funds offer advantages over individual stocks, as the fund manager tracks the industry/sector developments for investors. Since the performance of sector funds fluctuates depending on how the respective sectors/industries are performing in the market, a wrong selection of sector/s can adversely impact the overall portfolio returns. Therefore, it is essential for a sector fund investor to have the ability to withstand short-term fluctuations in order to enhance long-term returns.

Like sector funds, thematic funds also carry a high degree of risk. Hence, only investors who have experience of investing in equity and equity funds and have a high risk appetite should invest in these funds. 

Strategy For Investing

Broadly speaking, sector and thematic funds should constitute only a limited portion of an investor’s portfolio. Hence, only those investors who already have a well-diversified portfolio and who have the risk appetite to absorb extreme volatility should consider investing in these funds. Individuals can adopt different strategies to reduce the risks generally associated with such funds. One such strategy is to have limited exposure to three-four sectors/themes. It is also advisable to review your portfolio to ensure that you are not investing in a sector/theme that you already have a sizeable exposure to through other funds. Before investing in these aggressive funds, though, you need to assess certain key criteria that may be important to your profile. These are:

1. If you are investing in a sector fund, do you know enough about the sector and believe it is a good time to invest?

2. Are you willing to closely track performance of the sector vis-a-vis your fund’s?

3. Would you know when the sector looks overheated and move out?

4. Are you willing to book losses and exit if it becomes evident that the sector is not going to revive in a hurry?

Exposure One Should Have In Sector/Thematic Funds 

As a thumb rule, for an individual who has decent exposure to equity funds and is conversant with the behaviour of the equity market, around 10-15 per cent of the portfolio can be invested in sector and thematic funds. Remember, while these funds can be riskier than diversified funds, they also have the potential to provide better returns. The key is to select funds carefully and monitor their progress over the investment period. 

“The usual approach of buy and hold will not work with thematic funds. This year looks volatile mainly because of global issues. So, enter sector funds with 2-3 years timeframe,” says Rego. He further adds that themes such as Consumption, Agro, Technology and sectors such as Banking, Capital Goods, Manufacturing and Defence can be bet upon at this point.  

Risks Involved In Thematic Funds

On the flip side, there is always the risk that the market may take a longer time to recognize the views of the fund house with regard to a particular theme that forms the basis of a fund. 

Besides, there can be ambiguity in a fund’s definition of a theme. For example, some of the infra funds have a low percentage of exposure to the core infra sector and their portfolios have exposure to more sectors than even a well-diversified equity fund. There is also the risk of a fund manager’s style becoming too individualistic, which may be difficult to follow if the manager decides to leave the fund.

Suggestions while investing in sector fund:

- Let a sector fund be part of a tactical allocation. Avoid adding them in core family goals such as education or retirement.

- Restrict allocation to about 10 per cent of your fund exposure at the most.

- Avoid long periods of SIPs in sector funds (contrary to diversified funds) if you enter in an up-phase. There is little point averaging when the sector is headed in one direction – up. Similarly, do not keep averaging when a sector falls. You may be throwing good money after bad!

- Sectors such as FMCG and Pharma can contain declines to some extent but not others such as infrastructure or banking or media and entertainment. Hence, be aware of what to hold for a defensive strategy.

- If you believe you have made decent money (we would think returns of 20% annually over 2-3 years in a sector fund are good enough. Any absolute returns in high double digits or triple digits means selling then and there), simply exit and do not look back at opportunity lost. It takes more than an expert to time sectors.

- Take sector cues from diversified funds. Diversified funds are keen to play sectors to generate additional returns. Look at some of the top managed funds or SEBI’s data on how monthly sector exposures of schemes are being tweaked by fund managers. That may provide some cues on whether it’s time to exit or enter a sector.

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