Diversified equity funds are the mainstream high-risk high-return funds while sectoral equity funds can, supposedly, give higher returns at even higher risk levels. Kindly explain to me what is a diversified fund and sectoral equity fund, and how long one should keep his investment in the above.?
A diversified equity fund invests in the stocks of companies operating in different sectors and industries. For these funds, the choice of stocks is governed by factors other than the sector to which the company belongs, and hence they usually hold stocks of very diverse companies.
On the other hand, sectoral funds, as the name suggests, invest only in one sector. For example, a technology sector fund would invest in stocks of IT companies only.
Equities are considered to be the best asset class in the long term from the point of view of their ability to generate returns. However, along with the potential to generate superior returns, they are also the most volatile and suffer from a high degree of downside risk. Naturally, the funds that invest in equity stocks carry the same traits, and hence, are called high risk- high return funds.
However, sectoral funds carry a higher risk, along with a higher potential to generate returns. This is because their fate moves with the sector in which they invest. Therefore, if that sector performs well, they generate excellent returns.
But if the sector performs badly, which can happen due to many reasons, like a change in a government policy which can have negative implications for that sector, then the sector funds can also lose heavily. Unlike sector funds, diversified equity funds have the option to avoid the poor performing sector and look for investment opportunities elsewhere.
Take the example of oil sector, which is currently going through a rough patch. Because of this, most of the diversified funds have substantially reduced the exposure in the oil stocks.
However, oil-sector funds are restricted by their investment mandate to invest only in the stocks of oil companies, and hence, are performing badly. But as and when the fate of oil sector changes, these funds may move up the performance ladder to emerge as the top performers.
We believe that one should invest in a sector fund only if he has a fair amount of knowledge of that sector, and is quite optimistic about the outlook of the sector. Others would be advised to invest in the diversified equity funds only.
Equity investments tend to be more fruitful for investors who invest regularly over a long period. Once the time when you would be requiring your money nears, gradually shift your investments to debt-oriented schemes to avoid incurring losses, should the equity markets fall sharply at the last minute.