With the reforms being put on the forefront by the Government in power, it is likely to make certain sectors look attractive and may in turn induce many of you investors to invest in them. But the question here is - "is it worth going top-down in your investment approach and be exposed to sector concentration?" While all the pink papers as well as business channels often paint some picture or another on various sectors - be it retail, banking, FMCG, pharma, oil and gas, infrastructure and capital goods amongst others, it vital in our view to have a fairly diversified portfolio across asset classes and within each asset class as well, as it can enable you to reduce the portfolio concentration risk.

Let us take you back in time. In the year 2007 when the equity markets were buzzing, the infrastructure theme was much talked about, as everyone inferred that enough measures are taken for the infrastructure theme to grow. The pink papers too made the whole infrastructure theme look bold by flashing headlines like - "Infrastructure sector will be a key contributor to our economic growth"; but soon as news of U.S. sub-prime mortgage crisis emerged in January 2008, ripples were sent to across various developed and emerging nations including India, and the much boasted about infrastructure theme / sector lost its steam. Several infrastructure companies which had leveraged their balance sheets suffered in pain, since sales dropped and stiff interest cost on borrowed funds started biting into their profits. Taking into account these economic equations, stocks in the infrastructure theme / sector too were battered, and when Lehman Brothers (once one of world’s largest bank) went bust (in September 2008) the severity escalated. Later due to Lehman Brothers news, even the Indian financial system - banking stocks were negatively impacted. But fortunately since our central bank - the Reserve Bank of India was prudent enough in not to adopt exuberant policy stance, the impact of global economic negativity was better controlled.

Now while you may say - "it was a one-off global event and the impact of it was on mainly two sectors", we beg to differ with you on that, because the crippling effect of the same was also seen in other sectors as well - be it FMCG, capital goods, media & entertainment, retail and many more. This is because several people had lost jobs which negatively impacted the consumption story, and inflation too was stiff for good seven months (i.e. April 2008 to October 2008). For companies too it was a tough time as their capex plans were derailed, and as a nation summing-up all these, we witnessed recession for good six months (since the Lehman Brothers bankruptcy). So, we suffered the pain for almost 13 months before we started a bull phase. We experienced a "see-saw" movement, which brought several investors wealth and health to risk - especially those who betted on sector funds heavily promoted and those newly launched in 2007 (especially energy & power funds and infrastructure funds).
 

How various sector funds have fared?

Scheme Name	6-Mth (%)	1-Yr (%)	3-Yr (%)	5-Yr (%)	Since Inception (%)	Std. Dev (%)	Sharpe Ratio
BANKING & FINANCIAL SERVICES FUNDS
Category Avg of Banking & Fin Services Funds*	-3.9	7.4	10.0	11.4	17.6	6.30	-0.13
BSE BANKEX	-4.5	8.6	9.4	7.9	-	7.69	0.08
ENERGY & POWER FUNDS
Category Avg of Energry & Power Sector Funds*	-9.3	-10.4	-7.8	0.2	1.8	5.85	-0.17
BSE POWER	-16.3	-13.6	-14.2	-8.8	-	6.42	-0.24
FMCG FUNDS
Category Avg of FMCG Funds*	27.1	32.2	32.6	21.1	16.4	4.28	0.45
BSE FMCG	29.6	36.7	29.0	21.0	-	4.32	0.38
INFRASTRUCTURE FUNDS
Category Avg of Infra Funds*	-6.2	-4.9	-3.4	-2.0	1.3	5.78	-0.13
CNX Infrastructure	-12.3	-16.5	-15.1	-11.1	-	6.97	-0.24
PHARMA FUNDS
Category Avg of Pharma Funds*	20.6	23.6	25.0	16.2	21.0	4.55	0.31
BSE HEALTH CARE	19.8	29.4	25.1	15.9	-	4.67	0.31
IT FUNDS
Category Avg of IT / Tech Funds*	4.0	26.0	10.2	2.7	9.9	5.51	0.07
BSE TECk	-3.5	12.8	3.0	-0.5	-	5.48	-0.03
MEDIA & ENTERTAINMENT FUNDS
Category Avg of Media & Ent Funds*	2.4	5.9	1.9	-0.1	8.6	5.80	-0.04
CNXMEDIA	10.6	14.5	0.2	-8.8	-	6.11	-0.05

NAV data is as on Sept 12, 2012. Standard Deviation and Sharpe ratio is calculated over a 3-Yr period. Risk-free rate is assumed to be 6.37%)
*Category average is been calculated taking into account the all the funds in the respective categories
(Source: ACE MF, PersonalFN Research)  

The table above reveals how various categories of sector / thematic funds have fared over different time frames. The infrastructure funds and energy & power sector funds which were promoted in gung-ho and were much talked about (in the exuberant bull phase prior to the emergence of the U.S. sub-prime mortgage crisis), have shown a dismaying performance over a 3-Yr and 5-Yr time frame - in fact eroded investors’ wealth. Thus although they did well during exuberant times prior to the emergence of the U.S. sub-prime mortgage crisis, the bashing which they took in during the aftermath is showing a bearing on their returns even present times as the interest rates are still hovering near elevated levels.

Likewise, media & entertainment funds which were launched in pomp haven’t shown a glitzy performance either. The slowdown in lifestyle and leisure expenses by individuals amid the emergence of the U.S. sub-prime mortgage is still showing it negative effect; since in present times the worries in the Euro zone are sending shivers to the domestic economy.

However, amid the turbulence in the global economy only FMCG, Pharma, Banking & Financial Services and to some extend by IT Funds have managed to exhibit appealing returns. It is noteworthy that IT funds have managed to report gains supported by pressure on the Indian rupee which in turn has aided their underlying stock in the portfolio (especially those who had an export oriented revenue stream) of the funds to perform better, while Banking & Financial Services sector have benefited from prudent regulations and policy initiatives from the RBI. FMCG and pharma funds, on the other hand have depicted their defensive traits and delivered appealing returns amidst turbulence in the global economy. It is noteworthy that during the aftermath of U.S. sub-prime mortgage crisis (from 2008 and early 2009), Pharma funds refrained from showing a magnanimous fall, and thus in present time the returns are appearing appealing in current times. Likewise FMCG funds have able to provide stunning returns well supported by the steam in the consumption theme in India, despite a slowdown in the global economy.
 

Performance of various sector funds

(3-Yr average returns of sector funds is as on Sept 12, 2012)
(Source: ACE MF, PersonalFN Research)  

Thus if we illustrate the aforementioned table, taking into account the average returns over a 3-Yr time frame for the respective categories, the chart above depicts how they have fared.

Hence a broad assessment reveals that, most sector funds - especially non-defensive ones tend to do well when they are the flavour of the season, or some policy announcement supports their up-move. But when they go out of flavour, they don’t shy away from disappointing you.

In the current times, although the Government has increased Foreign Direct Investment (FDI) in multi-brand retail to 51% and in civil aviation upto 49%, which is likely to make the investment sentiment upbeat; it is vital to recognise that actual translation into capital flows would be subject to predictive and conducive tax regime. Hence, while there are companies within the retail and consumption likely to benefit, it would be prudent to wait and watch whether synergies are emerging with domestic and foreign companies. Also, unless that happens, we may not witness the positive impact of increase in FDI limits in the economic growth of our country, at least in the short-term.

Hence it is vital for you not get swayed by swanky stories published by pink papers or broadcasted by glamorous business channels. While they are doing their job of increasing their TRPs (Total Rating Points), it is critical for you to do your job as well of taking prudent investment decisions. Also while your mutual fund distributor / agent / relationship manager may say - "Having sector funds is like adding salt and pepper to your portfolio"; we believe that you got to recognise that the same "salt and pepper" can be added to your portfolio through diversified equity funds, as they are free to invest in various sectors / themes as well (when they look promising) and exit from them as the story fizzles out. In fact if you want to take advantage of various opportunities in respective sectors we recommend that you look at some good "opportunities style" diversified equity funds, which follow strong investment systems and processes.

Moreover, since diversified equity funds truly undertake diversification strategy for you in its true senses (as they hold stocks from various sectors / themes); they provide you better safety as the specific exposure to a sector / theme is reduced. While investing in diversified equity funds, we opine that investors should have a long-term horizon and adopt the SIP (Systematic Investment Plan) route of investing as it would provide you the advantage of rupee-cost averaging along with compounding.

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