Sunday, November 12, 2006

Portfolio Classification… (Cont.)

Passing through the portals of Portfolio Classification…

Index Funds

Index funds are equity funds that invest in exactly the same stocks (and in the same proportion) that make up the market indices like the BSE Sensex or the NSE Nifty Index. So what's the advantage of an index fund? The fund manager can programme a computer to just follow the index and pick stocks without putting in hours of his time in research and stock picking. So, the cost to the mutual fund for managing an index fund is low. It benefits investors in the form of low fees. The other advantage is that you cannot do worse than the BSE Sensex or the NSE Nifty. Simply because the index fund is replicating the movements of the index, NAVs of such schemes would rise or fall in accordance with the rise or fall in the index, though not exactly by the same percentage due to some factors known as "tracking error" in technical terms. Necessary disclosures in this regard are made in the offer document of the mutual fund scheme.

Sector Funds

Sector Mutual Funds are those mutual funds that restrict their investments to a particular segment or sector of the economy. There are a host of sector specific funds like FMCG, MNC, IT, New Technologies, Services, PSUs, Infrastructure, Pharma, e-commerce, Petroleum, Contra etc. These funds concentrate on only one industry. The idea is to allow investors to place bets on specific industries or sectors, which have strong growth potential. These funds tend to be more volatile than funds holding a diversified portfolio of securities in many industries. Such concentrated portfolios can produce tremendous gains or losses, depending on whether the chosen sector is in or out of favour. If the sector performs well, sector funds yield higher returns when compared to other funds. Diversified Equity Funds might not profit much from windfall gains in one sector, as they will be neutralised by bad performance results in other sectors.
The basic disadvantage of Sector Funds is that the portfolio manager has to confine his investment to one area. Even if the manager knows that the performance of the sector may not be good, he is forced to do so and is limited because of the scope of the fund.

Hedge Funds

Hedge Funds employ speculative trading principles - buy rising shares and sell shares whose prices are likely to fall. They hedge risks in order to increase the value of the portfolio. Hedge funds typically charge a fee greater than 1%, plus a "performance fee" of 20% of a hedge fund's profits. There may be a "lock-up" period, during which an investor cannot cash in shares. They are not common in India

Leveraged Funds

Leveraged Funds make speculative and risky investments, like short sales to take advantage of declining market. The main objective of the fund is to increase the value of the portfolio and benefit the shareholders by gains exceeding the cost of borrowed funds. They are not common in India

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