Don't look just at past performance of sector funds

Investors should do shorter-term SIPs, around six months, before deciding to continue

The most common approach while buying a mutual fund scheme is to look at past performance. Financial planners would also add another line: See how the scheme has performed over two cycles — one bull and one bear — to see how it has managed during good and bad times. Unfortunately, the same theory does not apply when investing in sector funds. Many investors would be eyeing some sector funds, such as technology and fast-moving consumer goods (FMCG), because they have withstood the fall in markets better.

Over the past year, the category average returns of technology funds (-1.35 per cent) and FMCG funds (0.90 per cent) have performed better than diversified-equity categories. The category average returns of large-cap funds is down -9.07 per cent. But, there has been diverse performance on the sector fund front. While some have done better, many have suffered. For example, banking funds (-14.25 per cent) and infrastructure funds (-11.93 per cent) have fared quite badly, according to data from Value Research. The Sensex is down -1.58 per cent in the same period.

 

  Unlike diversified equity funds, which invest in a variety of sectors based on the fund manager’s views, sector funds can invest only in one sector and often get caught in bad cycles.

When a sector is witnessing a bull run – technology in the late 90s or infrastructure in 2004-07 – funds based on that sector can give stupendous returns. But, when the bull run ends these funds can languish for several years.

The main advantage sector funds offer is that some sectors are always favoured more by the market at any given point. The best-performing sector also keeps changing from one year to another: Consumer durables in 2015, banking in 2014, IT in 2013, and so on. The best performing sector year-to-date is IT. “Any investor who can get his sector calls right can substantially boost returns,” says Kaustubh Belapurkar, director of manager research, Morningstar India.

 

However, remember that sector funds are a high-risk category. And, the fund manager also faces the problem that he cannot exit the stock easily if prospects of the sector are weakening. Their narrow mandate can turn into a handicap at such times.

Knowledgeable investors, who have spent a lot of time doing research about the prospects of a sector, may bet on sector funds. Second, sector insiders, who get to know in advance what is happening in their sector, may buy these funds. Beware, however, that when a sector insider bets on his own sector, he runs concentration risk. “If the sector witnesses a downturn you could lose your job. At that very moment the value of your investments in that sector would also shrink,” says Vishal Dhawan, chief financial planner, Plan Ahead Wealth Advisors.

A few caveats for investors. These funds are only for savvy investors who have the requisite risk appetite. “First build a diversified portfolio comprising both equity and debt funds and only then invest 10-15 per cent of your equity portfolio in sector funds,” says Vidya Bala, head of research, Fundsindia.com. Also, these are not buy-and-forget investments. You also need to time your exit correctly. “Cyclical sectors in particular need to be watched closely,” says Bala.

High valuations are another pointer that it may be time to exit. Investors should also book profits in these funds once they have achieved their target return or after every sharp run-up.