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Should you have sector funds in your portfolio?

April 19, 2013 . Vidya Bala
Most sector funds lagged behind their diversified, actively managed peers between 2003 and 2007. That means, there are no secular bull runs in sectors, not even in robust sectors such as FMCG or pharma.

For those of you not new to mutual funds, the above question would have crept in your mind at least a few times in the past couple of years. Many of you also ask us if you can invest in an FMCG fund or banking fund and so on.
Our response has been “be aware of the risks and the effort involved in sector funds before you choose to buy one”. So what are the risks and what kind of special effort does this call for? Let’s look at them.

Before we move on, a quick note on sector/theme funds. These funds seek to predominantly invest in the sector/theme stated in the offer document. A FMCG fund for instance, invests in consumer plays and their proxies while a banking fund would invest in banking and financial services-oriented stocks.

A theme, on the other hand, can be slightly broader – like investing in MNC stocks or Lifestyle-related stocks, or investing in certain international regions and so on.

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That means, instead of taking limited exposure in sectors/themes the way diversified funds would, sector funds place all their eggs (read – your money) in one basket, taking focused bets. To that extent their risk-reward ratio is expected to be higher than diversified equity funds.

Performance cycle
You are unlikely to have missed the toppers’ list in mutual funds being dominated by FMCG, pharma or banking funds in the last three or five-year performance chart. Commendable no doubt and we will leave it there.
Now let’s just step back and take a look at the performance of some of the sector funds between 2003 to 2007 (5 years) and 2005 to 2007 (3 years).

sector funds
Two points emerge clearly from the above table: one, most sector funds lagged behind their diversified, actively managed peers over this period.
That means, there are no secular bull runs, not even in robust sectors such as FMCG or pharma (we will discuss why this is so later).

Two, the returns between peer funds within each sector varies so much, that fund choice becomes crucial (while diversified funds too have variance in performance, the difference is not as stark) to outperform.

The fall
Now, the above was just to illustrate that sector funds are far from invincible.
That is not all. The fall from grace can also hurt a lot. Remember the dot com burst in 2000. Franklin Infotech fell 40% that year, 35% the next and managed just 8% returns in 2002. FMCG and pharma funds too had 3 consecutive years of negative returns then, some of them falling more than the broad market indices. And you are only too familiar, with the infrastructure funds’ performance in recent times.

Are some sectors not secular?
Many of you have asked us this question: “sectors such as pharma or FMCG will always see healthy growth, given the Indian consumer spending story. So what’s the fear of under performance?” True, but what you may have to see is relative performance. The period 2003-07 was a story of ‘growth’.

That means sectors such as engineering, auto or capital goods outperformed the more steady ones like FMCG. Typically, a high GDP growth in the economy means that growth sectors do well.

But post 2007, with the outlook for growth sectors looking bleak, the cash-rich defensives were paid a premium. Hence the market re-rating of these sectors and the bull run that followed. If the growth story revives, it is quite possible that you see a 2003-07 scenario being played out.

sector fund2

But I am not making any forecasts here. I would just like that you ask yourself the following questions before investing in sector funds:
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?

If you are willing to do these, then here are a few simple suggestions:
1. Let a sector fund be part of a tactical allocation. Avoid adding them in core family goals such as education or retirement.
2. Restrict allocation to about 10% of your fund exposure at the most
3. 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!
4. 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.
5. If you believe you have made decent money (we would think returns of 20% annually over a 2-3 years in a sector fund is 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.
6. 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 its time to exit or enter a sector.

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41 thoughts on “Should you have sector funds in your portfolio?

  1. Dear Vidya Mam,

    I am not a fan of Sector funds. It’s all about time in the market rather than timing the market. I am afraid, Indian MF Investor is not savvy enough to analyse sectoral trends and act accordingly. Why to take undue risk to generate that extra alpha. Give your money to a seasoned fund manager and an AMC having robust processes in place. As you have rightly analysed with the help of historical data that diversified equity funds have outperformed their peers over long term and that too quite convincingly.

    Warm Regards,
    Aditya

    1. Hi Aditya, you have summed it well. A very prudent thought and approach and no doubt it will help build wealth efficiently in the long run. Tks, Vidya

  2. want to invest 50K in SBI Emerging business fund for one year, Kindly suggest, i choose this fund or select some other fund.

    Need your suggestion.

    Thanking you.

    Regards,
    Pramod

    1. Hello Pramod,

      We would not ideally recommend an equity fund for a one-year time frame as you can get hurt in short-term market falls.
      If you have a particular goal or time frame in mind, pl. use our Ask Advisor feature (in your FundsIndia account) to write in your requirements/savings amount be it SIP or lump sum and we will suggest funds that will fit your time frame and risk appetite. You can use the mail back feature or schedule a call with our advisor for the same. tks, Vidya

  3. Hi Vidya,

    Would you call UTI MNC fund a sectoral or diversified. Would this fund be good one for diversification into into FMCG & pharma ?

    Thanks,
    Nimesh

    1. Hi Nimesh, UTI MNC is a theme fund..it will invest in stocks of multi-national companies. MNC stks are mostly from FMCG, pharma and capital goods/engg. space. Since the last-mentioned sector is under performing, MNC funds are overweight on the first two. You would have to take a call on whether to invest in a theme fund and are willing to track the same for right entry and exit. Typically MNC funds do well in a volatile market, given their exposure to FMCG, pharma but lag in a prolonged bull market. For instance in 2006 and 2007, MNC funds lagged behind and were almost in the bottom quartile of performance charts. Hence, while MC funds may be a porxy for FMCG or pharma, you need to know the fortunes of the sector well and track them. thanks, Vidya

  4. Good article. Sectoral funds have had a fair share of laggards in the past, but i believe that consumption related (FMCG) funds and Banking sector funds could be a part of one’s portfolio. FMCG – owing to a fairly inelastic nature of business, and Banks – owing to regulations ( lets not get into the Cobrapost etc expose here). I wouldn’t go with Pharma unless there is a fund that invests predominantly in generics. The R&D expenses and the rate of success associated with it, approvals from FDA and other authorities etc make things fairly complicated for a retail investor to stay invested in a Pharma fund, in my view.

    Unless all the Pharma firms spin off their research units like Sun Pharma did – the R&D arm trades as Sun Pharma Advanced Research Company (SPARC)

  5. Is SBI FMCG & ICICI DIRECT PLANS are good to invest money for 5 – 10 yrs. In between I will do additional purchase also.

    1. Hi Sagar, You may invest in FMCG if you can track them and time their exit and entry. FMCG funds can’t go wrong for the time frame you mentioned but one cannot be sure if they will beat other diversified funds over a 10-year period. Hence, an active strategy of profit booking will be needed. We don;t know what you meant by ICICI Direct plans..there is no such fund.

  6. Thanks for the article, My question is during the asset allocation, how much percent should allocate for sector funds. Like large cap 50%, large and mid cap 20% and small mid cap 30%. so where should we put the sector fund and how much?

    My second question is HDFC top 200 fund is large cap or large& mid cap. In money control site its is come under large cap and other sites as large and midcap. similarly Birla frontline equity fund, Quantum long term equity fund is come under which category?

    1. Hi Arnab,

      There are no fixed rules for an investor to hold X% in large or Y% in mid-caps. These are purely customised to suit an investor’s risk appetite as well as goals. But in general. sector funds being high risk category, would ideally entail not more than 10-15% exposure in one’s portfolio. Besides, it would require a very active profit booking strategy.

      The classification of mutual funds in different portals keeps varying based on the criteria they use to assess the market-cap of the stocks held by the fund. But if you go by the offer document and the fund strategy – HDFC Top 200 will predominantly invest in the top 200 stocks by market cap and will also invest some proportion outside that. So it is predominantly large cap. This is the case with Quantum Long Term Equity as well. Birla Sun Life Front Line Equity, on the other hand, will qualify as a large-cap fund.
      Tks,
      Vidya

  7. Here is what I have observed…

    1. There are no Index linked ETFs for the Pharma/Healthcare and FMCG sectors available to trade.
    2. ALL the Pharma/Healthcare and FMCG sector funds have outperformed the Sensex, but underperformed their own sector indices by a big margins. Doesn’t indicate any of these funds are being managed well.

    Questions:
    1. Should people still invest in these funds, or invest in individual stocks of their preferred sector, if they are comfortable doing so?
    2. Are their any ETFs for pharma/healthcare and FMCG sectors in pipeline? An index linked ETF may just perform better than these poorly managed funds.

    1. Hello Vikas,

      Easy questions first 🙂 There are no sector ETFs in the pipeline. These are not large/well-constructed indices nor are they in the F&O segment. Hence it may be difficult to mimic them.

      To answer your first question, your observation is right that FMCG and pharma funds lagged the sector indices (not true of banking though). This is not really their fault. The sector indices we are talking about are, as I said, poorly cosntructed, exceedingly concentrated and not even fully representative of the sector. Take the BSE FMCG for instance. It has just 11 stocks in all and ITC has 53% of the weight with another 18% to HUL. Imagine a fund with such concentrated exposure (as it is sector funds do take concentrated exposure but not to this extent). Also consumer durables are in a separate index. Besides, allied consumer stories will not feature here. Sugar, retail chains, jewellery chains etc are all consumer stories. Unlike in countries such as the the US, our sector indices have a long way to go. Until then, ETFs are unlikely.

      If someone is well-informed about stocks and fundamentals of companies, then it makes sense to pick them based on sector fortunes.

      Thanks, Vidya

  8. mam if someone wants to invest Rs.5 LACS in mutual funds for capital appreciation then what type of mutual funds he should go for? Should he invest in sectorial funds also?

    1. Hello Ankit, If the time frame is over 5 years, then diversified equity funds with a mix of midcap funds would fit the bill. Sector funds can be added upto 10% only if the individual can reasonbly time entry/exit. Shorter time frame would call for higher allocation to debt. thanks.

  9. Hi vidya,
    Pharma sector is going down these days, And it will be for some time. I think may be because of recent FDI’s regulations for mfg and selling generic drugs. Is it good time to be invested in Pharma funds?

    1. Pharma sector’s recent drop is more due to rupee appreciation and lack luster results of some of the companies. Also, market is likley to focus on cyclical sectors over the ensuing months and ignore defensives. But Their long-term prospects remain good. But hope you contain your exposure to less than 10%. thanks, Vidya

  10. HI Vidya,

    I am new to Mutual Fund and my query is all the Mutual Fund investment are interest based investment ?

    If am invest in any Mutual Fund, is Mutual Fund company or Stocks in that fund will provide any interest to that fund to raise the investment value.? Please let me know.

    Thanks,
    Rafi

    1. Hello Rafi,

      There is no ‘interest’ in mutual funds as they their returns are linked to market – whether it is equity or debt. The gains you make on investing is your ‘returns’ or ‘income’. Eg. If a fund NAV moves from Rs 15 to Rs 50, then Rs 35 is your gain. thanks, Vidya

  11. hello vidya mam..
    I wish to invest lump sum of 50 k -1 lakh in mutual fund as there is market correction for 1-2 years ..my queries are
    1. is this the right time to enter. .or should I wait for some time.
    2.is pharma fund will be better choice. if yes which one? reliance or sbi?
    3. or diversified equity will be good choice? if yes suggest me one or two funds.
    4.or 50 k in pharma or 50 k in diversified equity will be better choice?
    thanks in anticipation. .I m ready to take risk…

    1. Hello Sir, thanks for writing to us. I will be constrained from giving any portfolioa dvice in this forum, If you are a FundsIndia account hoder, please use the ‘advisor appointment’ feature in the help tab in your accoutn and our advisors will help you design your portfolio based on your requirement. But what I can tell you is that we strictly do not recommend a 1-2 year time frame for any equity fund – of any category. We recommend at least 5-year holding as we do not know how cycles will play out. If you are ready for risk, it means you are ready for capital loss as well. So please decide your time frame if you want to build long-term wealth. thanks, Vidya

  12. Hii Ms Vidya..I want to ask is Birla Sun life MNC Fund a sectoral/theme Fund, if we dont go by the name, it looks like its a diversified equity multicap Fund..is it not? And it has been advertised as a midcap fund but now it seems it is no longer a midcap but largecap? How would you look at this Funds amd its prospects ahead.
    Thanks a lot 🙂

      1. That said, I have read that article, well first of all thank you for you kind reply and I want to say as its mentioned in that article that Birla MNC fund is not actually a thematic fund but a well diversified fund..and in the starting of this article you have mentioned there is no secular bull run in sectoral funds..so does this thing applies to Birla mnc fund..can we have it as one of the core portfolio Fund..because it has shown good past performance..so going in at present juncture (after mid December) would be fine (pe 40-50)
        Thank you

  13. I have Reliance Pharma and ICICI Technology funds in my portfolio, which comprise almost 60% of my MF portfolio. Others are Bluchip and Midcap funds. As of now, Reliance Pharma has a 14% return, while others are at breakeven. What would be your advice?

  14. The gain is only capital gain then how all people are saying power of compounding? ?please give an idea how it is working in mutual fund?

    1. Hello Sayooj, Sorry for the delayed response. if you invest Rs 10 and it earns Re 1 and your NAV is Rs 11. This additional Re1 is further reployed and compounds itself. Compounding happens by gaining further on your gains. Vidya

  15. Thanks for article. I want to know about banking sector fund as icici banking
    I have SIP in ICICI banking and financial Fund for Rs.2500. its around 25 % of my portfolio . What should i do…stop it for while or continue ??

  16. Thanks for article. I want to know about banking sector fund as icici banking
    I have SIP in ICICI banking and financial Fund for Rs.2500. its around 25 % of my portfolio . What should i do…stop it for while or continue ??

  17. As SBI is not collecting debt income from PSU banks from their profit, is it good time to enter into PSU bank related Mutual funds ?

      1. Siddharth, Sorry for the delayed response. Many funds have already entered and gained a bit with that strategy. You need to be careful what you choose. Vidya

  18. Hi Vidya,

    If you make MF portfolio with sector funds like one fund of FMCG,Pharma, Technology, Logistic etc. and invest by SIP then this strategy work as diversification of fund allocation.

    What’s your view?

    1. Hi Nikunj,

      There are two drawbacks to this strategy. First, you would have to change the weights of each sector depending on its prospects. For example, if you had held a pharma fund, it would have been a drag on your returns unless you either stopped SIPs, or reduced the amount to bring its allocation down. Holding cyclical funds such as infrastructure again would have put your portfolio through a period of underperformance and then outperformance. Diversified funds would do this sector juggling within their portfolio. Second, you don’t have a variety of sector funds. You may be restricted in terms of fund choice (for instance, there are only two FMCG funds, one entertainment fund, one commodity fund) and you may not have a fund itself in some sectors that may have growth prospects. Examples include chemicals, fertilisers, textiles, and so on. Tactical allocations to sector funds if you have the wherewithal to track sectors are a better strategy.

      Thanks,
      Bhavana

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