Are Sector Funds a Good Choice? Are Dividend Plans a More Conservative Option?

Recently, I've noticed that a lot of sector funds are performing very well. Is it a wise option to go for the dividend plan rather the growth plan to be more conservative? Will the dividend option also take a beating when the markets fall drastically?
- Chandrasekkar Narayanan

There are two separate and unconnected issues in your questions. One is that of sector funds and the other of dividend plans vs growth plans. Let's discuss them one by one.

There is no reason to invest in any sector fund. Ever. The performance of sector funds is an illusion. Over any period of time, the stock markets always favour some sector of the economy more than others. That's in the nature of markets. Therefore some set of sector-specific funds are always doing better than others. Over the last many years, the favoured sector has rotated through technology, autos, infrastructure, FMCG and perhaps some others too.

In its day, each of these was doing better than diversified equity funds. This is not a coincidence but a mathematical certainty. Since diversified funds invest in a number of sectors, their performance is always a weighted average of those different sectors. Therefore, the best of those sectors are individually always doing better than diversified funds.

Therefore, if you look at mutual fund performance at any point of time, it always looks foolish to have invested in diversified funds rather than X sector. However, it's only when you take a long period into account, you realise that the identity of X keeps changing in unpredictable ways. Not just that, there is a reversion to mean so today's top sector often tends to fall to the absolute bottom. There are plenty of former fans of technology and infrastructure funds who will vouch for this.

Also, there is a more fundamental reason for not dabbling in sector-specific funds. The main reason for investing in mutual funds is to get the services of an investment manager who does the research and makes the choices for you. If you have to bother yourself with which sector is doing better, then what's the point of a mutual fund? The fund manager of your diversified fund will invest in whichever mix of sectors makes sense at the moment.

As for the dividend-vs-growth choice, the answer is almost as clear. The goal of equity investing is growth. The only reason to go for a dividend plan is if you need regular income. Even then, regular withdrawals from a growth plan might make more sense.

However, we feel that you need a little bit of clarification about what is the meaning of dividend in mutual funds. Compared to corporate dividends, this word has a completely different meaning in funds. It is not an additional income but just a withdrawal. If the value of your investment in a fund is ₹1 lakh, and the fund gives you ₹5,000 dividend, then the next day the value of your investments will be ₹95,000. There is no additional benefit. A mutual fund dividend just means taking some of the money that was already yours and giving it to you.

Therefore, our advice would be to completely change the paradigm within which you are thinking of fund investments. Choose a set of good diversified funds and invest in their growth plans. When you need the money, redeem that amount. Try and do so after a year so that there is no tax. Forget about sectoral funds as well as dividend plans.