Do not go overboard on sector funds

If you have invested in mutual fund schemes that invest in Fast Moving Consumer Goods (FMCG) stocks a year back, you would be sitting on a neat 41% returns today. This category is the best performing one, followed by banking funds (annual returns = nearly 21.50%) and pharma funds (annual returns = close to 21%).

In comparison, Bombay Stock Exchange's Sensitive Index or Sensex and National Stock Exchange's 50-stock index, Nifty, have returned around 12%.

Even in 2012, financial sector funds delivered an average of 59% in the year as against 57% returned by the BSE Bankex, as per a recent Morningstar report. This was largely on hope of a rate cut and good financial results by private banks. As a result, fund managers increased allocation to banking and financial stocks, also in equity diversified funds' portfolios. Average exposure to the sector in equity diversified funds' portfolios went up to 26% in November 2012 from 20% at the end of 2011.

Yet the advise to individual investors is to tread with caution when it comes to sector or theme-based funds. Largely because investing in theme-based funds leads to concentrating your portfolio unlike equity diversified funds, which invest across sectors and market cap.

Plus, investors may not understand the inherent risks involved in a specific sector. Typical example could be the dotcom boom, when many invested in the IT sector. And did not even manage to their principal amount when the sector went bust.

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. Therefore, financial planners suggest investing only 10-15% of your portfolio in such schemes.

There are positives for banking funds on the hope of further interest rate easing. Fund managers hold 26% banking stocks on an average. Investors should consider a combination of large and midcap funds, says Dhruva Chatterji of Morningstar.

But, this may not the right time for defensives, which have a shelf life, which mostly is during a volatile market condition. Allocation to pharma stocks started going down by end of 2012, he adds. Defensives performed very badly in 2006-07. In 2011, defensives performed very well due to volatility in the market. In first quarter of 2012, defensives slipped after sectors like banking, realty, infrastructure, which underperformed in 2011 bounced back. But downgrade fears help defensives move up again.

Lately, technology funds have also been doing well with over 17% return in the past 6 months. In the past 3 months this category has give 8% and 7% in the past one month. Infosys turnaround and good earnings from Wipro, HCL Tech have helped the sector.