Diversification is a rather underrated criterion in the context of investing. That perhaps explains the popularity enjoyed by sector and thematic funds. These funds function on the proposition of capitalising on attractive investment opportunities in a single sector like technology or themes like infrastructure or the spending prowess of the population (consumption).

However, by operating in a limited investment universe, such funds deprive investors of the benefits of diversification, something which is the cornerstone of mutual fund investing. Sector/thematic funds also tend to have a unique performance pattern; typically these funds deliver in short bursts and can even outperform their peers from the diversified equity funds segment. However, over longer time frames (3 years or longer), these funds tend to lag diversified equity funds. Hence the ability to deliver an enduring performance is something that most sector/thematic funds lack.

In the recent past, equity markets have been through an interesting phase. After having touched record highs and then falling sharply, now markets are on an upswing yet again. At Personalfn, we thought it would be good time to study the performance of Principal Focussed Advantage Fund (PFAF), a new fund offer (NFO) launched in the midst of the bull run in 2005. PFAF has been positioned as a scheme which will invest in no more than 6 sectors at any point in time. The intention is to benefit from opportunities in a select few sectors that are dynamically chosen.

Principal Focussed Advantage: The performance

	1-Mth (%)	3-Mth (%)	6-Mth (%)	1-Yr (%)	Since Incep. (%)
Principal Focussed Advantage (G)	13.77	-4.42	-0.28	26.20	27.80
S&P CNX Nifty	14.30	5.21	10.33	42.29	-

(Source: Credence Analytics. NAV data as on August 21, 2006. Growth over 1-Yr is compounded annualised)

Since inception in March 2005, the fund has clocked a growth of 27.80% CAGR. Over the last 12 months, PFAF's net asset value (NAV) has appreciated by 26.20%. The fund has consistently trailed its benchmark i.e. S&P CNX Nifty (42.29% over 1-Yr). Clearly, it has been a far from happy outing for investors in the fund.

Would investors have been better off investing in a diversified equity fund which invests across multiple sectors? Examining the performance of some of PFAF's peers can help us answer that question. From the same fund house, we have chosen Principal Growth Fund a predominantly large cap fund which invests a smaller portion of its assets in mid cap stocks and Principal Resurgent India Equity  a flexi cap fund which invests in stocks across market segments, for the purpose of comparison.

Similarly, diversified equity funds with well-established track records like HDFC Top 200, Franklin India Bluechip and Sundaram BNP Paribas Growth have been chosen. Unlike PFAF, none of the aforementioned funds have any restrictions in terms of the number of sectors they can invest in.

Principal Focussed Advantage vs. Peers

Diversified Equity Funds	NAV (Rs)	Assets (Rs m)	1-Mth (%)	3-Mth (%)	1-Yr (%)	Since Incep. (%)
HDFC Top 200 (G)	93.98	11,340.0	14.65	4.53	49.44	34.39
Franklin India Bluechip (G)	109.87	21,040.3	14.99	3.99	45.15	29.97
Sundaram BNP Paribas Growth (G)	57.13	1,255.7	12.58	1.33	42.83	25.35
Principal Resurgent India Equity (G)	60.54	3,298.3	12.70	-0.43	32.95	34.86
Principal Growth Fund (G)	42.61	3,257.1	16.33	-1.89	31.12	28.49
Principal Focussed Advantage (G)	14.05	731.4	13.77	-4.42	26.20	27.80

(Source: Credence Analytics. NAV data as on August 21, 2006. Growth over 1-Yr is compounded annualised)

Both the fund house peers i.e. Principal Growth (31.12%) and Principal Resurgent India Equity (32.95%) have outperformed PFAF (26.20%) over the last 12 months. Likewise, schemes from other fund houses i.e. HDFC Top 200 (49.44%), Franklin India Bluechip (45.15%) and Sundaram BNP Paribas Growth (42.83%) have scored over PFAF by even greater margins.

PFAF's proposition of delivering capital appreciation by investing in a limited (not over 6) number of sectors has evidently failed so far.

 

Albeit the fund has failed to match its peers and the benchmark index at this stage, going forward, an equally radical turnaround cannot be ruled out either. Such a performance is typical of high risk  high return equity funds. Given that PFAF's proposed investment style and its nature was explicitly evident right from the NFO stage, investors in the fund who are feeling aggrieved at present should perform a reality check on their risk profile.

At Personalfn, we have always maintained that retail investors are better off investing in conventional diversified equity funds. Conversely, sector/thematic funds are best suited for informed investors who have a view on the sector/s and can time the entry and exit of their investment.

Our advice to investors  employ the services of a qualified investment advisor and ensure that your portfolio is in line with your risk profile at all times. Irrespective of how unique a given investment proposition is, it should find place in your portfolio only if it can add value to your portfolio and matches your risk appetite.

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