Taking a sector call

Sector funds form the aggressive part of your portfolio. Here are some clues on how to manage them for great returns in the long run

When asset allocation is done, there is always one part which is specifically meant for getting you aggressive returns. Typically, this portion is small, somewhat like 10 to 15 per cent because the risks are rather high. And your financial planner could ideally put it in stocks or mutual funds. When it comes to aggressively investing through funds, it is sector funds that comes to mind immediately.

As the name indicates, such funds are dedicated funds, investing in stocks belonging to a particular sector or industry. The advantage of such funds is that there is concentrated exposure in one kind of sector which cannot be attained through diversified funds as they are bound by regulation and can only have a 10 per cent holding in a particular sector (at the time of purchase). Sector funds do not operate under any such restrictions.

Also, it helps you to take a contrarian view on the market. For instance, the pharma sector is presently suffering from a downward rating because they are not considered 'hot'. But if you, as an investor, believe that the sector is due for a re-rating, you may not get a meaningful exposure unless you purchase a pharma fund.

However, there are certain things to watch out for while investing in a sector fund. For starters, you need to possess impeccable timing. The biggest risk that accompanies such investments is that you may be tempted to invest in these funds after the sector has run up substantially. A prime example of this is the early 2000 boom of software companies when many investors burnt their fingers by investing in technology funds and lost over 60 per cent of their investment in the next two years. On the other hand, if you had purchased Reliance Diversified Power Sector Fund last year, you would have enjoyed a one-year return of a staggering 110 per cent this year.

As you can see, timing the entry and exit is extremely difficult as one only gets to know in hindsight that the sector has peaked out. Moreover, most sector fund managers are bound by certain guidelines that they can only invest in that particular sector irrespective of the changed fundamentals. So the onus is on you to enter and exit it timely.

Of course, there are some instances where the fund house has broadened the mandate later to become more inclusive like Franklin Internet Opportunities Fund, which was converted into Franklin India Opportunities Fund but such changes do not happen regularly. Also, when such moves happen, it can dilute the fund focus and returns may be adversely impacted. And that defeats the entire purpose of investing in them.

Another important point while investing in such funds is the choice of the fund itself. This is because there is a wide variation in the performance of two peer sector funds. For instance, Reliance Pharma's one-year return is 22 per cent while SBI Pharma's return for the same period is a negative 4 per cent. There are two variants to sector funds:

lThematic funds: These are funds devoted to investing in stocks belonging to a particular theme such as infrastructure (UTI Infrastructure) or domestic consumption (Birla Gen Next). These may be slightly less riskier than conventional sector funds, as the themes are generally broad enough to accommodate a basket of sectors.

l Sector exchange traded funds (ETFs): These are similar to ETFs based on broad-based indices such as the Sensex and Nifty, except that they track sectoral indices. Benchmark Mutual Fund is the pioneer of sectoral ETFs in India. Although it has only launched one such ETF so far, the Banking BeES which tracks the NSE Banking Index, there are several others in the pipeline.

While investing in such funds follow a few general rules as compared to diversified funds as you will have to be more vigilant for signs of change in the sector and on the stocks therein. For instance, in case of an FMCG fund, you will have to track the monsoon situation more closely as many FMCG stocks depend on rural demand for their revenues. Similarly, in case of pharma funds, tracking the exchange rate is important as most of our frontline pharma companies depend heavily on export revenues.

Also, in case of auto and banking funds, changes in the domestic and global interest rate scenario should give you clues about the changing demand conditions.

The writer is a certified financial planner