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The Contradictions Of Specialised Funds

A look at last year's worst performers showed how fickle specialised funds can be. But specialised funds show up best performing list as well. So what does that mean as far as investing in them goes

Last week I wrote about equity mutual funds' performance for the last one year and discussed the lessons to be learnt from the funds that had been the worst-performing funds of the year. This week, I'm ready with some (I hope) interesting observations about the best-performing ones. However, I must confess that it's with more than a little uneasiness that I'm doing these year-end lists. For the next few days, newspapers and magazines are going to be full of 2007 this and 2008 that. We're going to be inundated with all sorts of lists, some interesting and some useful and some so utterly pointless that they'll leave you wondering why they were written at all. I think so many lists are so useless not because the list-maker is doing something wrong but that the calendar year is not a natural unit of time for most human activities. Here I am, trying to see how mutual funds' investments did over the last 365 days. However, by social convention, I'm ignoring the fact these particular 365 days have no special significance that is difference from any other 365 days. I mean I could have written with great fanfare about investment returns from September 15, 2006 to September 14, 2007 and that would be just as relevant as the calendar year 2007. A sensible time period for studying investment returns could be what can be called an entire market cycle, that is, one entire bull-run and one bear phase. Such a period tests fund managers' mettle and exposes their biases in a more severe way than a straight trend. Anyhow, the fact is that people look at the year as a basic unit of time even in areas where this doesn't make sense and there's little point complaining that this doesn't make any sense.

What do the year's top performing funds tell us? What really leaps out is the success of mutual funds that describe themselves as infrastructure funds, or which adhere to some other investment universe that has something to do with infrastructure. Interestingly, this is not something new-a similar list for 2006 had a somewhat greater dominance of infrastructure funds. The somewhat clichéd India-shining story is about building India, and anyone who is interested in building India isn't having any problems doing well on the stock markets. However, when I look at the broader picture then the funds have performed best reveals a pattern similar to the ones that have performed the worst. We saw last week that the bottom of the list was stacked with specialised funds that adhered to a narrow investment theme. Well, so is the top of the list. Of the top 20 funds, around 11 can be described as speciality funds. Doesn't this disprove what I said last week? No. On the contrary, I think it proves the point more emphatically. The problem with specialised funds is not that they never do well, but that they tend to fluctuate from one extreme to another. When the special idea that they are based on is doing well, they are on top but when the going gets tough, then they sink to the bottom. A performance ranking with speciality funds stacked at the top and bottom is nothing surprising or contradictory. So if you find infrastructure funds bunched up much higher than IT funds this year, I think that says more about the risks of chasing narrowly-defined past performance rather than what you should or shouldn't do in the future.