The investor's fling with sector funds continues. This is apparent from two factors -- the sector fund initial public offerings that were launched in 2004 and the investor response they generated.
So have sector funds delivered? They have on some counts, but not without extracting their pound of flesh in the form of intense volatility.
There can be no two ways about the fact that sector funds give investors an opportunity to capture potential in a particular sector/group of sectors that is otherwise not possible in a diversified equity fund.
While diversified equity funds also take sector bets, they do this in a 'diversified' manner, which works against you if you are the type who prefers taking focused sector bets. In a diversified equity fund, the fund manager works with a different mandate -- to maximise gains by diversifying across sectors/stocks.
This is opposed to what a sector fund manager is mandated to do -- to maximise gains by taking concentrated sector bets.
Aggressiveness begets volatility
| SCHEME NAME | NAV (Rs) | 1-Mth | 3-Mth | 1-Yr | 3-Yr | 5-Yr | SD (%) |
| MAGNUM CONTRA FUND | 13.83 | -2.54% | 20.30% | 55.98% | 59.09% | 19.96% | 7.41% |
| PRINCIPAL RESURGENT IEF (G) | 37.20 | -3.60% | 11.31% | 8.99% | 53.07% | NA | 8.30% |
| CANEXPO (G) | 29.06 | -4.88% | 17.37% | 21.81% | 38.54% | 3.66% | 8.59% |
| TATA LIFE SC & TECH FUND (A) | 21.92 | -6.07% | 7.21% | 21.58% | 37.37% | 4.65% | 8.85% |
| KOTAK MNC SCHEME | 19.29 | -3.83% | 13.47% | 33.32% | 36.88% | NA | 6.75% |
| ALLIANCE BUY INDIA FUND (G) | 13.01 | -6.20% | 30.89% | 48.17% | 36.87% | NA | 8.50% |
| UTI GSF- SERVICES SECTOR FUND | 23.78 | -6.82% | 9.87% | 12.67% | 36.54% | 12.78% | 7.15% |
| BIRLA INDIA OPPORTUNITIES PLAN B | 26.13 | -5.09% | 8.15% | 16.91% | 33.88% | -1.46% | 6.71% |
| BIRLA MNC FUND (G) | 63.90 | -4.90% | 12.42% | 19.97% | 32.07% | 10.61% | 6.57% |
| DSP-ML TECHNOLOGY.COM (G) | 9.73 | -4.33% | 6.11% | 17.28% | 31.25% | NA | 6.78% |
Sector funds not only attempt to maximise gains by taking concentrated bets, they even succeed in doing so, at least in spurts.
For instance, Alliance Buy India (30.89%) Magnum Contra Fund (20.30%) have done significantly better than diversified equity funds (see table below) over the 3-Mth time frame. In fact even over the 1-Yr time frame both these funds have fared decidedly better than their diversified equity peers.
Now for some bad news. While sectors funds have succeeded in delivering growth, this has come at a price to the investor. The price has come in the form of higher volatility in performance.
Take Alliance Buy India in the above table. While its 1-year performance (48.17%) is undoubtedly better than most peers across both groups (sector funds and diversified equity funds), it has also seen distinctly higher volatility (Standard Deviation -- 8.50%).
This is because sector funds bank on a particular sector/group of sectors to post capital appreciation and when the target sector(s) looks up, they ride the growth.
Eventually, the sector peaks at a level and then declines. This proves to be the undoing of the sector fund. Without the benefit of diversification, they cannot take refuge in other sectors to stem the fall. This exposes investors to higher risk from erosion of net asset value (NAV).
Diversification saves the day
| Diversified Equity Fund | NAV (Rs) | 1-Mth | 3-Mth | 1-Yr | 3-Yr | 5-Yr | SD (%) |
| RELIANCE GROWTH FUND (G) | 106.88 | -3.32% | 19.89% | 37.73% | 71.76% | 21.16% | 7.84% |
| FRANKLIN INDIA PRIMA FUND (G) | 104.39 | -2.79% | 18.91% | 35.00% | 69.22% | 23.61% | 8.23% |
| RELIANCE VISION FUND (G) | 79.22 | -2.89% | 15.92% | 17.99% | 68.86% | 24.13% | 7.90% |
| UTI VALUE FUND | 28.11 | -4.68% | 15.58% | 18.41% | 55.11% | 14.31% | 7.88% |
| HDFC CAP BUILDER (GR) | 33.63 | -1.90% | 18.55% | 41.95% | 51.56% | NA | 6.95% |
| TATA EQUITY OPPORTUNITIES (A) | 26.46 | -3.67% | 15.26% | 21.21% | 50.31% | 21.66% | 8.94% |
| DSP-ML OPPORTUNITIES (G) | 24.36 | -4.51% | 15.01% | 19.06% | 50.07% | NA | 7.89% |
| GIC FORTUNE 94 | 17.13 | -3.55% | 18.22% | 12.29% | 48.64% | 15.18% | 8.27% |
| MAGNUM GLOBAL FUND | 14.64 | -4.87% | 17.30% | 53.79% | 48.28% | 2.60% | 7.50% |
| HDFC TOP 200 FUND (G) | 47.46 | -6.04% | 10.64% | 12.69% | 48.25% | NA | 7.97% |
With a diversified equity fund, the scenario is a lot different, as the fund is never over-exposed to a particular sector like a sector fund. As a consequence it does not fall as hard and even then, it has the benefit of diversifying across sectors that are not as adversely hit by market volatility.
So investors in diversified equity funds may not register the strong spurt in growth that sector fund investors witness, however, they don't fall as hard either. So the risk is considerably lower for a diversified equity fund investor.
A lot of investors find the appeal of a sector fund irresistible, which is fine if you have understood the risk implications of investing in them.
Also it is important to have an informed view on the sector else you could be entering a sector fund when you should actually be exiting it and vice versa.
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