Gaurav works in the treasury department of a leading private bank. He believes that the interest rates are headed downwards and there will be huge gains in the bond portfolio of banks. He expects that these gains to reflect in the prices of banking stocks in the medium term but he is not sure which banking stock to invest in. He starts a systematic investment plan (SIP) to invest in a banking sector fund. Sector funds are those mutual fund schemes that invest only in stocks of a particular industry or sector. For instance, banking funds invest in stocks of banks and financial institutions. FMCG and pharma funds invest in stocks of FMCG and pharmaceutical companies respectively. So, rather than going with a single stock, Gaurav has chosen to go for a bouquet of stocks in the same sector.
To an extent, Gaurav is right. There are advantages to investing in a sector fund. A banking sector mutual fund scheme can help him to:
- Diversify risk within the sector: By investing in a sector fund, you do diversify risk among the stocks in the same sector. A specific stock may suffer or perform badly due to a company specific development but the other stocks in the same sector will provide the cushion.
- Use fund manager expertise: A fund manager, using the research resources at his disposal, is more likely to choose the best stocks in a sector than an average investor.
- Outperform the broader markets: If your conviction and research about a sector is right, you do stand to reap better than market profits. Let’s look at how various sectoral indices have fared over various periods vis-a-vis CNX Nifty. The comparison is as on December 31, 2014
As you can see, CNX Bank, CNX FMCG and CNX Pharma have outperformed broader markets (CNX Nifty) significantly over all the terms while CNX Metal and CNX Realty have underperformed over all the terms. Hence sectoral bets, if you get them right, can give you handsome returns.
Should you invest in sector funds?
We are sure you have such convictions too about the sectors you work in. Then, should you invest in sector mutual funds too? Not so soon. The outperformance of CNX Bank, CNX FMCG and CNX Pharma is just one half of the picture. The performance of CNX Metal and CNX Realty indices shows what can happen if your conviction goes wrong. Let’s list out a few other issues with investing in sector specific funds.
- Timing the market: To grow wealth in stock markets, time in the market is more important than timing the market. Unfortunately, to make money in the sector funds, you may have to learn to time the market especially in the cyclical sectors such as banks, cement , steel etc. For example, banks (or banking stocks) outperform when the interest rates are low or are expected to fall and underperform when the interest rates are rising. So, to invest in a banking fund, you have to be at the right turn of the interest rate cycle to outperform broader markets. Though you must choose the SIP route to build exposure to such funds, you must close those SIPs and exit position in the sector funds when the sector fundamentals begin to deteriorate.
- Low diversification: Sudden adverse development in a particular sector will hit all the funds investing in stocks in that sector. However, the sector funds (that invest solely in stocks in that particular sector) will be hit the hardest. In an equity diversified fund, you would have stocks from other sectors to soften the hit.
- Equity diversified funds give a decent exposure: Fund managers of the diversified funds increase allocation to sectors that are expected to do well in the near future. Over the last year, it was expected that interest rates would fall and ground economy would improve. Banking stocks were likely to be the earliest and the biggest beneficiaries. Hence, equity diversified increased their exposure to banking stocks. HDFC Large Cap Fund, a large cap equity diversified fund, increased its weightage to banking stocks from 25.6% (as on December 31, 2013) to 35.2% (as on December 31, 2014). Hence, even by taking a position in an equity diversified fund, you are taking a higher allocation (than the benchmark index) to the banking sector. The weightage of the banking (and other financial institution) stocks is approximately 30%. Even by investing in an index fund (tracking CNX Nifty), 30% of your funds will get invested banking stocks.
- Finding good companies in a single sector is not easy: A mutual fund typically invests in atleast 15 to 20 stocks. Finding these many good companies in a single sector is not easy. For example, the incumbent central government is expected to give a strong push to infrastructure and housing sectors. This may make you bullish about companies in construction, engineering and real estate. However, if you are asked to name a few listed companies with excellent balance sheet and high standards of corporate governance in construction, engineering and real estate, you would struggle to name even five. The fund mandate does not allow much leeway to the fund manager and pick stocks outside the specific sector. Hence, by choosing to invest with sector funds, you may be betting your money on stocks on low quality companies.
- Correlation: If you work with a software company, you salary, future salary hikes and job security are linked to performance of the IT sector. If you concentrate your investment too in the technology sector funds, you are taking higher risk since your salary and investments are correlated with the performance of the IT sector. A slowdown in the IT sector will be a double whammy.
PersonalFinancePlan Take:
Considering both pros and cons of investing with sector funds, we suggest that the equity diversified funds are the way to go. However, if you have strong knowledge about a particular sector through professional experience or otherwise and can judge the impact of various events or government policies on stocks in that particular sector, then it may not be exactly unwise to invest in sector funds. However, investing in sector funds is akin to investing in stocks. You invest in such funds only till the time fundamentals of that particular sector are good. You exit your position as soon as sector fundamentals begin to deteriorate. Hence, though you should still take the SIP route to invest in sector funds, SIPs should be closed as soon as sector fundamentals begin to deteriorate or the industry cycle starts to turn for the worse. Under equity diversified funds, you continue with your SIPs to get the advantage of rupee cost averaging. Keep the following suggestions in mind while investing in sector funds:
- Invest only in those sectors where you have strong background knowledge
- Total allocation to sector funds shall not exceed more than 10% of your total equity portfolio
- Monitor sector fundamentals. Exit your position if the fundamentals have worsened.
Deepesh is Founder, PersonalFinancePlan.in
14 thoughts on “Should you invest in Sector Funds?”
Hi Deepesh,
I started SIP of total 12000/- p.m. across 7mutual funds in May 2015.
Among these i had probably made a mistake of selecting Franklin Build India Fund-Growth-Direct (Thematic Infrastructure). Total investment in it til now has been 18,000/- while current valuation is below 16,000/-. At that time i was a beginner & made the decision seeing excellent return in 1,3 5 year horizons in moneycontrol and also thought it to b better than pure sectoral fund as it covers multiple sectors within the broad theme of Infrastructure.
In the last several months i hav studied about the negative side of Sectoral funds…
Now can u please suggest me whether to continue my SIP or should i stop it and start SIP in some other diversified fund?… Please suggest
Hi Biswadeep,
Stop SIP in the fund for sure. Take exposure through equity diversified funds only.
Have financial goals in mind when you start investing. This will help you selecting the right kind of funds and also help maintain investment discipline.
Thanx a lot for ur prompt reply.
Surely i wil stop further SIP in this thematic fund..it was a mistake.
But should i liquidate the money after stopping SIP (Exit load 1%) & come out with negative return or should i hold on to it for some more time without making any further contribution to see if my investment makes some positive return & then liquidate as & wen the sector rises…?
Difficult to answer. Given it is only a small part of your portfolio, you continue for sometime and sell after 1 year and shift to a diversified fund.
Hello Sir, I am beginner in MF investment. I want to start two SIP of 1000/- each. As I am not very much aware about investment please suggest any two plan. I am thinking for ICICI Prudential Value Discovery Fund and HDFC Mid Cap Opportunity Fund.
Ranjana,
I don’t give recommendations without considering financial goals and risk profile.
About the two funds, both are good funds. Both are mid cap funds on paper but have begun to act as multi cap funds.
I won’t comment if you should have only these funds in your portfolio.
Hello Deepesh,
I started SIP of 25000/- across 11 mutual funds.
Goal 1-Retirement-28 years- (16000)- (Frank High growth company,ICICI Focused Bluechip,SBI Blue chip,Mirae asset opportunities,DSP micro cap,UTI mid cap & ICICi Banking,financial sector fund)
Goal 2-Daughter Education-18 years-(5000)-(Frank prima plus and HDFC Mid cap)
Goal 3-Daughter Education-25 years-(4000)-(UTI Equity and Frank smaller companies)
Debt-EPF & PPF – yearly investment around 300000.
Is 11 mutual fund portfolio is good.Or should i need to reduce number of funds in my portfolio.
I’m planning to invest 5000 more coming months in Mutual fund.Intrested in SBI pharma fund.whats your suggest? can i goahead with SBI pharma or invest existing funds in my portfolio.
Thanks in Advance
Dear Kannan,
Eleven funds is too high. You can do with four or five.
Avoid sector funds unless you are an expert.
I do not recommend funds without proper risk profiling and financial goal assessment.
But must say most of the funds you have are good.
Invest 5,000 in the existing funds. Avoid SBI pharma.
Sir,
I have invested in 3 sector funds (not big amounts), with no actual investment plan or horizon. I just tried timing (market downfall in Feb, 2016) the market for these funds as many articles mentioned to know the rate cycle in these sectors.
As for 2 funds in these are now showing returns more than 28%. I am not sure how these will exactly workout in future & neither do I have any plans on starting any SIP in it, anytime in future.
I have not completed a year in these funds. So an exit load (1% on total amount withdrawn) & 15% STCG tax will apply on exit in coming days. What should I do, considering if I redeem these funds completely, I will still be making around a decent 22-24% return.
What would you suggest?
Thanks in advance.
Dear Aniket,
Difficult to comment.
If these are your only investments, then you can switch to diversified funds.
Otherwise, if you are investing in MFs on a regular basis, there is no need to switch. You can continue in these funds. Just that do not make further investments in these funds unless you know the industry well.
To be honest, my guess is only as good as yours. Can’t say how equity markets will perform in the next few months.
Thanks for the quick reply.
I do have other investments as well. 3 ongoing SIPS (2 ELSS & 1 Debt).
I plan to purchase 1 more debt/small-cap fund & Start SIP in that as well.
I want to exit the profit making funds. Use this money for liquidity or may be put that money in the existing debt fund (if not required currently). That is the plan.
Just that the banking sector & infrastructure sector funds that I want to redeem (after 5-months of purchase) have already given so much profit (as mentioned in earlier comment) that I wanted to know, what you think. Is it better to exit with profits of around 22-24% (after taxes) or stay invested for more than 1-yr.
Thanks again.
Aniket,
A lot depends on you. Nobody wants to make any lesser profit than you are already sitting on.
I don’t know how banking or infra funds will do in next 6-8 months. Nobody knows to be honest.
Quite possible I ask to you to sell and the funds run in the next few months.
Alternatively, it is also possible you hold on to the units and the markets fall.
I see a lot of anxiety. Better you sell those units and relax.
Why don’t you sell units in the funds where you are sitting on loss? You will be able set off gains in banking or infra against loss in the other fund.
Hi Deepesh,
Thanks a lot for your reply.
Even I was thinking of the same. I am relatively new to mutual funds investment & had come into this in the lows of September, 2015 & then again in February, 2016. So right now, don’t have any funds in loss as such. 😛
But thanks again. Will think over this & take appropriate decision (mostly sell) as per the returns (after exit load & STCG).
Thanks again.
Regards,
Aniket
You are welcome, Aniket.
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