A well-chosen theme-based fund could prove fruitful over the next few years

Following fads blindly is never a good strategy, be it in fashion or investment. However, investors tend to do just this, latching on to the stock or fund that is popular at a given time. Rationality takes a backseat, leaving investors with lemons in their portfolios when the so-called hot items crash. Thematic or sectoral funds are a case in point. As the name suggests, thematic funds are built around an investment theme based on a broader economic trend, be it consumption, financial services, infrastructure, technology or natural resources.

Sectoral funds, on the other hand, invest in companies belonging to a particular industry. These are usually bought when the buzz is at its peak. For instance, infrastructure funds were a rage in 2006-7, when multiyear growth in the Indian economy had everyone gushing about the massive infrastructure opportunity. Today, these are the worst performing funds. Worse, these are not the only funds that have burnt investors' fingers. By the time people get a whiff of a good theme, the opportunity has run its course; there is either very little upside left or the fund is on its way down.

When to invest

The temptation to invest in a particular theme is strong when everybody is talking about it. However, this may not be the ideal time to jump in. Valuations may already have run up as everyone rushes to grab a piece of the pie. For instance, consumptionoriented funds have become popular now. Last year, equity-FMCG funds yielded extremely good returns, far ahead of the negative returns yielded by other equity funds.

This outperformance could easily seduce one to opt for such a fund. But these have already had their time under the sun, feel experts. What, then, is a good time to enter thematic funds? One should go by the principle of equity investing, 'buy low and sell high', which applies to equity mutual funds as well.

Swapnil Pawar, CIO, Karvy Private Wealth, asserts, "The investment philosophy for thematic funds is similar to stock investing. Get in when valuations are down and stay invested to benefit from the growth." At times, some sectors or themes are ignored by the market for various reasons.

The stock prices are low either due to problems facing the industry it operates in or as a result of macro-issues plaguing the economy. When most investors exhibit an aversion towards these firms, you must consider investing in them. At such times, solid investments are available at bargain prices.

In most cases, these problems are temporary. Once the cycle turns and the issues are resolved, the firms with strong fundamentals will get back on a highgrowth track. If you buy at the right time, you will benefit from the jump in the stock price, and the rise in the NAVs of the related funds.

Where to invest, where not to

Over the past few months, the stock market has taken a severe beating due to various domestic issues and global concerns. Certain sectors have been sidelined, and as a result, their prices have come down. Investors would do well to identify such areas and take a position at the right time. A well-chosen theme-based fund could prove fruitful over the next few years.

Which are the themes or sectors that investors can target at this uncertain period? Hemant Rustagi, CEO, Wiseinvest Advisors, says, "The valuations appear attractive in many pockets of the equity market. Those who can digest the risk can opt for mutual funds based on these sectors or themes." Here are four sectors which are available at good valuations, but not all make for good investments.

Banking & financial services: This is a good option because it is currently witnessing an investor aversion. High interest rates have cut down its profitability. The non-performing assets (NPAs) are on the rise and net interest margins (NIMs) are being squeezed.

A fall in valuations is not surprising, with several banking stocks now trading at near book values. Experts opine that this pain is behind us and the concerns are already priced in. After the RBI's latest annoucement on bank rate hikes, the uptrend in the interest rate cycle has played out, feel experts. Pawar says a reversal in fortunes is on the cards: "Given the pause in interest rate hike indicated by the central bank, the areas sensitive to rates could make for a sound investment."

Technology: Given the slowdown in developed countries, stock prices of IT services firms had dragged down due to concerns over the sustainability of demand. However, these worries seem to be exaggerated as most IT majors continue to exhibit a decent growth in order books, with no compromise on deal pricing. The companies' revenue estimates for the coming quarters remain reasonably buoyant.

A rebound in outsourcing is expected to start in the coming months. Experts believe that tech-oriented funds could yield high returns for investors in the next few years and that the recent correction provides a good entry point as the downside is limited. "Most of the concerns on demand environment have already been factored into the stock prices of these IT firms," adds Pawar.

Infrastructure: This sector may not make for a good buy since it is facing a host of issues, which has resulted in stock prices taking a beating. Lack of long-term funding, high level of debt on books, poor governance and recent scams have plagued infrastructure firms. Worse, these problems are unlikely to disappear soon, and as such, infrastructure funds are expected to continue to struggle in terms of performance. These funds are also very loosely defined and tend to stray into several areas of the economy. So you will find an infrastructure fund investing not only in construction and engineering companies, but also in cement, telecom and banking.

This is the reason experts are circumspect about the theme. Says Dhirendra Kumar, CEO, Value Research: "It has been a struggle for these funds ever since the bubble was pricked in 2008. I don't see a revival for this sector anytime soon." Investors would do well to stay away from infrastructure funds for the time being, despite the low valuations of most stocks.

FMCG/Pharma: These two sectors have outperformed the market by a long margin over the past year. While the rest of the economy sputtered, companies in this segment have been able to ride out the storm given the non-cyclical nature of business. They have witnessed a steady growth in volumes even though the margins were impacted due to the rise in input costs. Not surprisingly, the stock prices for these companies have gone up.

However, it will be difficult for these sectors to continue outperforming for a long time. Says Kumar: "Such funds will always stand out during bad times. However, they will not exhibit the same level of performance when the economy improves.

In fact, they tend to underperform the market during boom periods." This is the reason they may not make for sound investment at the moment.

Who should opt for sectoral funds?

Such funds are best suited for investors with high risk appetites and those who understand the nuances of the sector or theme. Even if you can digest the risk, these funds should not be a part of your core portfolio. Do not invest more than 10% of your portfolio in these. If you are investing in one, ensure that it adds value to your existing portfolio. Some of your diversified mutual funds may already be exposed to the theme of your choice.

Krishna Sanghvi, head of equities, Kotak Mutual Fund, says, "A concentrated approach will be too risky for some investors. They should not stray from the traditional diversified mutual funds." Hiren Dhakan, associate fund manager, Bonanza Portfolio, says, "Investors need to give five to seven years for these funds to work. Do not redeem your units in a panic when short-term concerns crop up."

Do not fall for marketing gimmicks of fund houses. They will launch funds when there is a buzz around a sector. It doesn't mean you should jump the gun.

Source: http://articles.economictimes.indiatimes.com/2011-11-07/news/30369523_1_thematic-funds-sectoral-funds-equity-mutual-funds/4