Sectoral delusions

As you would have seen, this issue's cover story is about sectoral and thematic funds. Our regular readers know quite well that we have always been deeply sceptical about sectoral funds. In Value Research's publications as well as in other media, I have always said without equivocation that there is no case for an investor investing in any such fund.

The rationale has always been quite clear to me. At any point, some sector or the other is doing better than the markets in general. That's in the nature of the markets. The equity market, on the whole, is the average of all its components. Obviously, some parts will be better than average, and some will be worse.

Consequently, a diversified portfolio never looks like the best bet at any point in time. It's a mathematical certainty that some sectors will always have better short-term performance than the market as a whole. This simple rule, which is almost a law of nature, is the source of the perpetual sectoral hype machine.

As you will see in our very well-researched cover story, we have had an absolute spate of sectoral and thematic funds over the last few years. This has absolutely nothing to do with these funds being suitable for investors and everything to do with these funds being good for the fund companies. Make no mistake; this is an exercise in artificial demand creation by hyping up some sector or the other and selling a product that the customers do not need.

None of this should matter to equity fund investors if they actually invested in funds the way it should be done. That means ignoring sectoral stories and just choosing diversified, general-purpose funds with a good track record. Such funds are supersets of all the stories that there are. There could be times when Banking, Energy, Infrastructure or Technology stocks make more sense than others. However, that doesn't mean that you, the investor, have to identify those times and then find the right sectoral or thematic funds to invest in.

This approach of chasing sectoral trends often leads to the cycle of buying high and selling low, as investors tend to enter sectors when they're peaking and exit when they've already declined. Moreover, consistently timing the market is extremely challenging even for professional investors, let alone retail investors. By sticking to diversified funds, you avoid the pitfalls of market timing and benefit from professional management across various sectors.

All this means is that if most of your money is invested in a general-purpose fund with a good track record, then the fund manager will appropriately emphasise Energy or Infrastructure or Technology stocks or whatever when it's the right time to do so. However, unlike a sectoral fund, they won't go overboard with that theme and stay within an overall diversification framework. So, when that sector goes out of favour, you won't be stuck with it.

This balanced approach provides a crucial safeguard against sector-specific risks while still allowing your portfolio to benefit from sectoral outperformance. It's important to remember that today's high-flying sector could be tomorrow's underperformer. By relying on a skilled fund manager to navigate these shifts within a diversified fund, you're better positioned to achieve consistent and long-term growth without the stress of constantly second-guessing market trends.

The entire point of mutual funds is that this is the fund manager's job, not yours. This is what you pay for. To get good returns from mutual funds, if the investor has to spend time and effort choosing or rejecting sectors, then the very idea of mutual funds has failed.

Whenever we publish an article on sectoral funds, I wish that we could just put a big 'NO' on the page and let that be. Unfortunately, the sectoral hype is so strong that a fair amount of research and detail is necessary to convince many investors of the actual situation. Our cover story of the month is one of our periodic efforts in this ongoing campaign.