For example, the category average return in FMCG funds is an impressive 19.48 per cent compound annual growth rate (CAGR) over 10 years. The Nifty and Sensex, by comparison, have returned 7.95 per cent and 7.73 per cent CAGR, respectively. The category average returns in large-cap funds for the same period, 9.83 per cent (CAGR), is a tad better than the Sensex and Nifty. Even other sector funds, such as banking, pharma and information technology, have performed better than the benchmark indices over the long term.
The question: Why don’t investment experts advise sector funds aggressively? “Sector funds have high utility. But they often aren’t promoted aggressively because of the high volatility they might see during some periods,” says Hemant Rustagi, CEO, WiseInvest Advisors.
It’s not that sector funds do not go through bad times. Pharma funds, over a three-year period, have returned 0.51 per cent (CAGR), whereas large-cap funds have returned 10.85 per cent. In the past year, even banking funds have taken a knock. With category average returns of 9.41 per cent, banking sector funds have given much less than large-cap funds’ 13.82 per cent return.
Jatin Khemani, founder and chief executive officer, Stalwart Advisors, a Sebi-registered independent equity research firm, says: “When you invest in a diversified equity fund, you have exposure to various sectors. It is your fund manager's job in these funds to go underweight or overweight on certain sectors. So your investments are well taken care of. But an investor who is market-savvy can use sector funds.”
According to him, some investors may be unhappy with their fund manager’s allocation to a particular sector. If they want to have more exposure to that sector, they can take the sector fund route. Many high-networth individuals take this approach. There is the option of the taking exposure to direct stocks instead of investing in the sector. But many investors, despite being bullish on a particular sector, might not be competent enough to do the bottom-up stock picking.
For instance, there is an increasing feeling among many investors that the pharma sector has gone through a rough patch since 2014. However, the fundamental prospects of this industry remain strong. In developed markets, there is a lot of pressure to reduce health care costs and India remains the cheapest manufacturer of generic drugs. Therefore, as companies get their act together in the matter of complying with US Food and Drug Administration (US FDA) regulations, things could get better for the sector in the future. Hence, they may want to bet big on pharma. But these investors might not know which pharma companies to bet on. Should it be Aurobindo or Sun Pharma or Lupin? In such cases, they could invest in a sector fund where they might let the fund manager pick which companies to invest in. The investor's role is limited to taking a call on the sector.
If somebody is very bullish on the infrastructure story now, he might again take a bet on a sector fund. The National Highways Authority of India is giving huge orders for road construction every month. Affordable housing has got the infrastructure status. A lot of new airports and ports are coming up. All of these will generate a lot of cement and steel demand. So, an investor might buy an infrastructure fund to play this story.
Such bets, however, work better when you are contrarian, and when you are ahead of the market. When the sector is already doing well, bets on sector funds could go wrong. “One should look at sectors that have done very badly over the past three-four years, and take a contrarian call on such sectors. One advantage of following a contrarian style of investing is that even if you are wrong in your thesis, you might still not lose significant money. Since you are buying a sector that is out of favour, valuations are at rock bottom, hence your chances of losing money are very low,” adds Khemani.
Rustagi suggests that an alternative approach could be to invest in several sector funds and thereby create a well-diversified portfolio. “Anyway, most diversified funds will have 70-80 per cent exposure to four-five sectors. So an investor could do the same.” Even for a stock investor who is bullish on a sector, he suggests buying 60 per cent stocks and 40 per cent sector funds. However, he cautions that investors in such funds have to be more alert and keep themselves well-informed about the sector to succeed.