FUND FLAVOUR
October 2010

Of exhilarating performance, expiry dates…

According to mutual fund rating agency Value Research, in the last one year, pharmaceutical sector funds have given almost 56% returns, fast-moving consumer goods (FMCG) 50%, banking 49%, and technology 38%. At the same time, equity diversified funds have returned 30% and the Sensex and Nifty have returned 17% and 18%, respectively. Yet, experts advise retail investors to approach theme-based or sectoral investments carefully. There are risks involved in a specific sector which an inexperienced investor will not understand. During the dotcom boom, many invested in the information technology sector. When the sector went bust, scores of them lost even their principal amounts. Bet on such funds only if you have a high risk appetite. While sector funds outperform the broader indices during good times, they fall as fast when markets head south. Sectors have a shelf-life — they perform only in a certain market cycle. You need to understand the sector and know what cycle it is in. You should invest only 10-15% of your portfolio for a minimum of three years in such schemes. A good way of investing in sector funds would be to opt for broader sectors, like healthcare instead of pharmaceuticals, or financial services in the place of a banking sector fund alone.

Infrastructure Funds
Out of favour…

There are about 140 funds which invest in broadly 25 themes in India. Fifteen of them are infrastructure funds. Infra funds are the only thematic funds which are of any meaningful scale. The amount of money in infrastructure funds is Rs 14,133 crore (May 31, 2010), distributed amongst 20 schemes. In fact, the assets of open-ended infrastructure funds account for over 10% of the total assets of equity diversified funds. Unfortunately, this category of funds is out of favour right now with investors simply because it has not been able to race ahead in the latest bull rally that started in March 2009. A fundamental reason could be the high exposure to Energy which was one of the top sectors of almost all the infrastructure funds in 2009. In terms of performance, BSE Oil and Gas (73%) and BSE Power (74%) could not hold a candle to BSE Metals (234%), BSE Auto (204%), and BSE IT (132.78%). But you cannot have a myopic view when investing in such a theme and you must be willing to ride the highs and lows. These funds have rewarded you quite well. During the previous bull run (June 15, 2006 to January 8, 2008), the average absolute return from this category was 89%, as against 69% from the equity diversified category (equity diversified funds excluding thematic infrastructure funds). Surprisingly, they did not fall too hard in the bear phase that followed.

Banking Funds
Brimming with success

The average performance by the top banking sector funds is really good. The quarterly returns are more than 16% and the annual returns are more than 50%. Post-March 2009, the top three banking funds gave very high returns - annual average of 128%, because of the “strong and supportive policies implemented by the Reserve Bank of India” according to a report on thematic funds by CRISIL. Banking and financial services sector funds generated impressive returns due to the rally seen in banking stocks, as the key policy rates were hiked by RBI. Banking Sector Funds returned 49% as against 30% by other diversified equity funds in the past one year.

Technology Funds
In tune with the music…

Technology Funds have done reasonably well returning 38% in the past one year, thus, maintaining their improved performance after being hard hit by the global economic crisis.

Auto Funds
Riding high …

Auto sector has woken from its slumber and has reached its pinnacle of success…but it has been a little more than a year since JM Auto Fund changed to JM Midcap Fund (still auto sector accounts for a third of the stocks in the portfolio). UTI Auto Fund is now the sole fund in this category.

FMCG Funds
Divergent delivery…

FMCG is one of the best sectors to get moderate returns with low risk. The Rs 86,000-crore FMCG industry is expected to witness a lot of action in 2010. With the economy showing signs of revival, the industry is expected to register a 15% growth in 2010 as compared to 2009. The industry will witness a spate of acquisitions & mergers in 2010. There will be a renewed focus on rural consumers too. The country's FMCG industry registered a 12% growth in 2009 despite the economic downturn. Funds that invest predominantly in FMCG stocks have been among the top performing thematic funds over the past couple of years. Not only did these stocks fare relatively better in the falling market of 2008, but they have also participated actively in the stock price rally since March 2009. FMCG funds have been the top performing set of thematic funds in the equity category for both one- and three-year periods. These funds averaged a return of 50% for one year, outpacing the diversified equity category average of 30%. Over a three-year period, the degree of outperformance has also been impressive with FMCG funds managing a 19% compounded annual return to the Sensex's 7%. The three FMCG funds, however, showed substantial divergence, with Franklin FMCG being the best five-year performer and the Magnum FMCG fund topping over one- and three-year time-frames. Despite the rise in input costs, FMCG industry is likely to sustain its robust growth momentum aided by increased rural incomes, taxation benefits, and gradual shift from the unorganised sector/regional players.

Pharma Funds
Divergence despite dream run…

The Indian pharmaceutical sector has had a dream run in the stock markets, with the BSE Healthcare Index returning a whopping 56% over the past one year. This not only betters the 17% returned by Sensex, but that of the broader market as well as a host of other sector indices. Pharma funds beat the two indices even over three- and five-year periods. Interestingly, pharma funds surpassed other sector funds as also the diversified equity funds category average returns over one- and two-year periods. Their impressive performance notwithstanding, pharma funds saw a wide divergence in their returns. While Reliance Pharma and Franklin Pharma funds consistently came up with ‘above average' returns across one-, three- and five-year periods, the other two lagged by a significant margin. UTI Pharma & Healthcare's performance was mediocre while Magnum Pharma scored poorly over the three periods.

PSU Funds
Promising potential…

With the government planning to raise Rs 40,000 crore through divestment in public sector units (PSUs), retail investors have a good investment avenue. PSUs have tremendous growth potential. They have helped in creating a diversified industrial base for the country. SBI Mutual Fund launched a PSU Fund in June 2010. UTI Mutual Fund, Religare Mutual Fund, and Sundaram BNP Paribas Mutual Fund had launched similar funds in 2009. There is a strong case for investing in PSU funds. The PSU Index has outperformed the Sensex in the last 10 years. Therefore, there is immense unlocked potential in these companies. In the last 10 years, the PSU Index has returned over 805%, while the Sensex has given almost 251% returns. Given the scale, the size and the reasonable valuation of most PSUs, holding these stocks can be a good bet from a risk-reward perspective. The PSU theme looks promising on the back of strong fundamentals of these companies, most being leaders in their sectors. During the economic slowdown, they showed greater resilience than their private sector counterparts. The new norm of minimum 25% public holding in all listed companies will help you get a good value for money and choice of companies.

Benchmark Mutual Fund has filed an offer document with the Securities and Exchange Board of India (SEBI) for the launch of six open-ended exchange traded funds (ETFs). All the planned launches are sector-specific. Benchmark has positioned itself as an index fund house. It already offers a Banking ETF, Gold ETF, and PSU ETF. Now the fund house wants to offer the entire range – IT BeES, FMCG BeES, Services BeES, Energy BeES, Pharma BeES, and Realty BeES.

…and diversification

Diversification is one of the cornerstone principles of mutual fund investing. Sector funds that focus on high-growth sectors or narrow niches of the economy tend to be volatile. It is generally not advisable to commit a substantial portion of your total assets to a single sector fund. Maintaining adequate diversification across sectors in your overall mutual fund portfolio is good investing practice. Having a sectoral allocation is alright if you know the sector well enough and have the risk-taking ability. However, even then, it is not a bad idea to diversify your risks through investing in a variety of fund types and thus a reduction in overall risk. After all, why put all your eggs in one basket?