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Tuesday, January 28, 2014

Sectoral Mutual Funds

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We must have all heard the saying “Still Waters Run Deep”. Why does this saying remind me of Sectoral funds ?. Sectoral funds require a thorough understanding. We need to tread carefully here. These are funds if handled and used properly can give us great returns and if not thoroughly understood and used can soon bring us to grief. Here this is like a hunter with a single arrow. He has to hit the deer. If he misses he loses everything

 

 

What Is A Sectoral Fund?

Here a Sectoral fund is a mutual fund which basically invests in stocks of a particular sector. It basically remains focused on the stocks of a particular business. These may be the Technology, Financial services, Telecommunications, Metals and Mining, Healthcare and Pharma, Real Estate and Infrastructure, Power, Oil and Gas, Shipping, Airlines Industry, Banking, FMCG and so on .Under the Sectoral funds we have the thematic funds which basically identify themes based on global trends or certain unique criteria such as a rise in disposable income of youth in India. Here an FMCG fund has a portfolio of FMCG stocks and a theme based fund might invest only in MNC Companies or in lifestyle stocks.

So How Do We Go About Investing In Sectoral Funds:

When should you invest in a Sectoral Fund? What Sectors should you buy in? These are the questions which must be constantly circulating in our minds? Here one of the most common techniques followed is to enter a bull market when it is just forming. Here when you study the market you will notice that most of the leading companies will belong to two or three sectors. First we mark the particular sector that we are interested in. This might be the Information Technology sector. We choose a good Sectoral fund which incorporates these market leaders in the particular sector such as Information Technology. Your work doesn’t stop here. Here you need to evaluate the past performances of the Sectoral fund in both the Bull and Bear markets.

What were the returns it generated in the past bull market? Having chosen to invest in the particular Sectoral fund commit money to that sector. Wait for the bull run to pause called a correction. Commit additional funds at this time. Wait for the bull market to approach its peak. You will come to know this through excessive optimism among the public, Newspapers projecting a great future for that particular sector, CEO’s of those particular sectors being highly praised and so on. These are the warning signals. Here Technical analysis also provides a clue as to where the market is heading. Here the markets might be headed for a spike top. Here we request the fund manager to liquidate bulk of our units in the Sectoral funds.We keep a small number of units behind for the final surge of power before the bull run dies down. Don’t you think this is risky stuff indeed …..We then wait for the next bull run in another sector and repeat the procedure.

Things To Remember While Investing In A Sectoral Fund :

Don’t Blindly Follow The Crowd: We have all heard of the herd mentality. All sheep blindly follow each other. Here we read in the newspapers of a bull run. Everyone encourages everyone else to jump into the market. Most of the people jump into these Sectoral funds when it is too late and the market has peaked out. Ironically they are ready for the fall in the markets.

Patience A Vice Or A Virtue: Always plan or target your time horizons.Here it is very difficult to time the markets as one cannot be too sure when a bull run begins or ends. Here if we stay invested in the markets for long time periods we can realize profits because even if we miss a single bull run we get other opportunities if we stay invested for 3-5 years .Look at a sector which has been out of favour for some time even though its financial fundamentals are good.

Experience Is a Great Teacher: Here we must choose a Sectoral fund which has a very good fund manager. Here we need to check the track record of the fund manager .Many fund managers fill up a stop gap role and we need to choose the fund manager with good credentials as well as good experience. An Experienced fund manager would have seen many market cycles and would know what to do best.

Keep An Eye On The Reasons You Want To Invest :

Here let us consider you invested in the market to tap the benefits of Infrastructure and real estate maybe even the International real estate. These gave stupendous returns in the period before the market crash. After the crash in the stock markets in the month of September in the year 2008 due to the US Mortgage crisis investments in US Housing and International Real Estate took a big hit. With the core purpose gone investments in these Sectoral funds no longer mattered. Always remember never to make Sectoral funds a core part of your portfolio and use them only for speculative play.

A Study Of The Factors Which Influence Sectoral Funds:

Business Cycles: Here we have the early cycle phase which is categorized by a sharp V-Shaped recovery from a recession. Here we notice a sharp growth rate in GDP. Profits rise rapidly. Credit is available easily. We notice an improvement in Net Sales. We notice a growth in employment opportunities and a rise in IIP the index which specifies production in the economy. This is then followed by the mid-cycle phase. Here we notice a positive but more moderate or a slower growth rate than as seen in the early phase cycle. We notice a growth in sales and inventories. There is strong credit growth and profitability is healthy. We then see the late cycle phase which is categorized by a rise in inflation. Here we notice tightening credit and reducing profit margins of the corporates. Inventory levels rise and sales slows down. Lastly we enter the recessionary phase. Credit is scarce and corporate profits decline.

How To Choose A Sectoral Fund And The Factors Which Influence Them :

Let us consider the early phase where air freight, road and rail transport ,trucking and also Information Technology stocks rally with the hope of increased consumer spending with an anticipation of an economic recovery. Container and Packaging Industries stock prices tend to rise in this period. Laggards in this cycle include Power stocks as these are affected by inflationary pressures and energy costs are low. Telecommunication stocks which have a defensive component tend to lag behind during this phase.

In the mid-cycle phase we see a boom in Software and computer peripherals and a rise in prices of Information Technology stocks. Here utilities and material industry stocks have tended to lag behind in this phase.

Here in the late cycle phase we see a rise in the energy industry and power industry stocks and also materials sector whose fate is tied to prices of raw materials. Here we notice a rise in Inflation. Here healthcare and consumer staples tend to do well. Information technology and luxury goods, fine clothing tend to experience a slow down during this phase.

Here in the recessionary phase defensive stocks such as Pharma stocks tend to hold their own. Here we notice that in recessionary phases we would not cut down on our essentials such as soaps, tea or toothpastes. FMCG stocks tend to do well in these periods. We would not cut down on our medical and healthcare costs. Here in these recessionary periods these stocks hold on. Information Technology and Consumer discretionary stocks tend to fall in these periods.

Here I would like to conclude this article by stating that even in downtrends and recessionary phases in the market certain stocks do prop up the market. Identify these sectors and stocks .As per historical studies FMCG, Pharma and Banking stocks generally tend to perform well or at least hold their own during the recessionary phase. Here a combination of sectoral funds can create a well diversified fund. This will take care of the limitations of the Sectoral funds. Here there is a famous saying “Every Dog Is Valiant At His Own Door”. Here however good we are or we say we are in timing the market one bad day can wipe out all our gains. Who could predict the stock market crash in September 2008. Here it is wise to note that “Caution Is The Parent Of Safety”.

 

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