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Stepping off the sectoral carousel

Whenever equities fall, some sector or the other is always doing better, but it doesn't actually matter

Stepping off the sectoral carousel

It's the kind of time that is an essential part of an investor's education. Equity fund investors of all kinds are getting a lesson in facing volatility with fortitude. And yet, at the same time, there are some false lessons too that need to be avoided. Probably the worst lesson that can be learned is that when the markets are down, some sectors still do well and the best approach is to identify the correct sectoral funds.

Right now, if you go to Value Research Online and look at the returns of different fund categories over various periods, then you can come to one of two very different conclusions. Either you could conclude that it's a volatile time and as an equity investor, one just has to live through occasional bouts of volatility. Or, you could conclude that technology (and possibly FMCG) sector funds are doing well and if you had known this secret, you could have invested only in these funds.

Of course, whenever a particular type of stock is doing well, a bandwagon effect arises, and any number of supposedly professional advisors decide to tell you that this is what you should be doing with your investments. Sellers start pushing funds that focus on that sector, seeing a clear opportunity provided that the trend continues. Obviously, for some time, the trend does hold. At this point it looks sub-optimal to invest in a diversified way. The hard thing to understand is that this is actually happening almost on a continuous basis. The equity market as a whole is always a composite of sectors that are facing varying fortunes. Whether the markets are stable or volatile, rising or falling, some sector or the other is always certain to be doing better than the average, or less badly than average. This makes it highly likely that a diversified mutual fund portfolio will always looks like a suboptimal choice.

However, inevitably, the law of averages asserts itself and the sector(s) that were doing well starts performing below average, and their returns revert to the mean. Those who climbed on to the bandwagon late are left with the worst results. In fact, the maths is generally even harsher. The reversion to mean often results in the formerly best sectors to fall to the absolute bottom, and create losses even when the rest of the market is booming. This is something that former cheerleaders of the tech, infra and many other sectors have learnt through painful experience. However, when one sees the excitement today, then it becomes obvious that the lessons have been unlearned by many people.

Does all this mean that investors should avoid sectors that are doing well? Surely, that's also a recipe for low returns. In either case, investing on the basis of momentum is not the smart thing to do.

The simple answer is that investors should let the investment manager of a diversified equity fund make the choice. After all, 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 track the markets yourself with which sector is doing better, then what's the point of investing in mutual funds?

As I've discussed earlier in this column too, volatility is part and parcel of investing in any equity-based investment. It's pointless to look at a particular period of volatility and over analyse it. Maybe it's interest rates and Trump's impending trade war today. Maybe it'll be something else tomorrow. It doesn't matter. Periodically, something or the other will always come up. It's a problem that is better recognised as the non problem that it is.