FUND FLAVOUR

October 2013

Sector funds invest only in the chosen sector. They get hit hard if the sector is faced with adverse developments. If you look at the performance of mutual funds in a particular year, the top performer is likely to be a sector fund. But the worst performer is also usually a sector fund. Moreover, the top performing sector changes every year. So, sector funds are highly volatile. While sector funds belong to the top end of the risk spectrum, under certain circumstances they can help reduce portfolio risk. In a portfolio of multiple mutual funds, a sector fund can reduce portfolio risk provided the sector has a low correlation with the other equity funds and has low sensitivity to macro-economic factors. The needs of the majority of retail investors are met adequately by a portfolio comprising half a dozen diversified equity funds.

Infrastructure Funds – a damp squib

Back in 2006-07, infrastructure was the way of the future. On every count, whether it was new projects, new businesses, massive IPOs, or infrastructure-dedicated mutual funds, it was a sector that seemed to encompass everything that was exciting about India’s potential. Today, a short half-decade later, the whole thing is in shambles. From the investor’s perspective, no matter which way you look at it, infrastructure is a disaster zone. Despite the fact that infrastructure equity funds rode on the back of market rebound to give investors 25% average gain in 2012, all infrastructure funds gave negative returns for almost all periods above six months.

Banking Funds – driving in top gear

The top performing sector funds at present are the banking sector funds. As per the analysis of net asset values for all mutual fund schemes during 2012, the banking funds gave an average 55% return in the year, as against appreciation of 26-28% in the broader benchmark indices.

Technology Funds – dismal show

IT funds, with a return of 6%, were the poorest performers in the year gone by as the chosen theme did not play out well as the winners. Equity funds have invested 10.5% of around Rs 1.9 lakh crore of assets under management in IT companies like Infosys, TCS, Wipro, and HCL Technologies. Equity mutual fund investment in technology stocks is second only to their investment in the banking sector, and much more than their allocations in defensives like FMCG and pharmaceuticals. Fund managers were betting on the technology sector at the beginning of the year on expectations of higher earnings due to a weaker rupee, as most of the technology companies earn more through export of services. But their bets have gone awry, with the rupee strengthening of late.

Auto Funds – slow down

Dun & Bradstreet has prepared a comprehensive Sectoral Outlook report on the Automobile sector for the year 2013 which showcases that achieving high growth rates is likely to be a major concern for the industry in 2013 but the auto industry is likely to gain considerably from the various initiatives on infrastructure development, rural focus, and the improved road infrastructure. Domestic mutual fund managers have taken a fancy for the auto-ancillary industry as an alternative investment option in recent times as the auto sector has slowed down. The auto-ancillary companies are holding firm in uncertain times and the industry has logged average sales growth of 30% in the past three quarters. Even though the demand from the original equipment manufacturers has dipped, the replacement market remains strong, which has helped these companies improve their operating margins to 20% from 15% over the past three quarters.

FMCG Funds – on the fast track

The Indian Fast Moving Consumer Goods (FMCG) sector is booming for the last several years and giving steady returns to its investors despite slowdown in the economy. FMCG sector has several multinational players with strong presence in India such as Nestle, Procter and Gamble, Gillette, etc. There is stiff competition among domestic companies, unorganized segment and MNC companies to increase their sales year-on-year, due to which they operate on low operational cost and margins. FMCG sector is performing well due to strong characteristics and dependence on consumption in domestic market. Mutual funds focused on FMCG are a close second, next only to the banking sector, with an average return of 48% in 2012.

Pharma Funds – a safe bet in difficult times

The past three years have been quite eventful for the global economy and financial markets. Sectors such as real estate, power, and capital goods, which were the investors’ favourites in the last bull-run have completely gone out of favour of late. However, pharma has been the only sector, which has been held up during this descending trend of the Indian equity markets, thereby, proving to be defensive and thus taking care of the health of investors’ portfolio. Being an export-oriented sector, the rupee's depreciation is likely to boost its earnings.

PSU Funds – out of favour

Mutual fund schemes investing in shares of public sector undertakings (PSUs) have fallen out of favour with investors. The assets under management of six such funds have dropped about 28% in a year to June 30, 2013 as declines in these shares have squeezed returns. Total AUMs of the six PSU funds stood at Rs 589 crore as on June 30, 2013 compared with Rs 823 crore on the same day a year ago, according to data sourced from mutual fund tracker Value Research. Average returns from this fund category have contracted 24%, compared with a 21% decline in the CNX PSE index. The BSE Sensex has risen by about 4.9%, while the NSE Nifty has risen 1.7%. Public sector companies underperformed partly because of the government’s share sale programme to meet its divestment target. It was the high exposure to some large-cap and mid-cap PSU stocks that led to the decline in the returns of these funds. Four of the six PSU funds have high exposure to the energy sector with more than half of the corpus invested in stocks of this sector. Financial sector stocks are the second largest category of stocks in these funds with an average exposure of 23.3% per fund. Two of the six funds in this sector are exchange-traded funds tracking PSU bank stocks. Valuations at this point are cheap and could turn out to be good buys from a long-term perspective.

Investors would be better off by investing in diversified equity funds with a time horizon of 3 to 5 years as the benefit of diversification enables them to reduce the risk of the portfolio. Moreover, diversified equity funds, which have a minimum 3 year track record from fund houses which follow strong investment processes and systems, can help tap investment opportunities in the various promising themes as well.