Sector plays are for the elite, if you were to switch on any of the business channels, you would find experts ranting on their favorite sectors. Even within the ‘Mutual Fund’ world, there are sector plays, however, for an average investor; this spectrum of investment remains a challenge.
Here, we decode the nuances of the strategy on how to play the sector theme – Getting the cycle right

Like everything else in life, sectors too have cycles, when the market moves, there is a tendency for some sectors to outperform and for some others too under-perform. A look at how various sectors have panned out over the past 5 yrs on a yearly basis will give us a fair idea of how this can work…

As one can see, there is no definite pattern that one can point to but on a general consensus, FMCG and Health care can be identified as relatively defensive sectors. During the meltdown in 2008 it would have been typically fruitful to stay invested in these sectors. On the other hand, sectors like Metals and Realty have turned out to be highly volatile sectors with multiple instances of gross underperformance.

A look at what panned out over the last 6 months could be interesting; this shows more precisely the volatility that sectors undergo over shorter horizons and this only get increasingly interesting to watch them on a weekly / daily basis. For the sake of simplicity and understanding, we have plotted only a few sectors.

Each sector is driven by different dynamics, eg. Interest rates could affect Auto, Bank, PSU sectors the most, and there are other sectors where the impact would be relatively low – Capital Goods, Power, Realty. On the other hand, exchange rate woes could typically affect IT, Metals, Textiles in different forms. Rise in commodity prices would impact Metals positively, but would be a bottleneck for realty, power sectors.

Food inflation would affect FMCG the most; however, the reduced investible surplus in the hands of the investor could typically affect other sectors as well.

This gives us a cue that macro factors of the economy are key to determining the sectors which will outperform and the ones which will fail to deliver.

Sector Mutual Funds: Do they make sense?

Sector fund is a mutual fund that concentrates it’s investments in a single sector of the market. So, a banking sector fund will typically invest all its money in banking and financial services stocks. Compared to this, a diversified equity fund will invest across various sectors such as banking, pharma, technology and industrial goods. Experts always advise newcomers to the market to start investing in diversified equity funds.

Sector Mutual Funds are perceived to be riskier than diversified equity funds and rightly so. Since sector funds have concentrated portfolios, the risk is much pronounced as compared to a diversified portfolio where the performance is not determined by a specific segment.

Pharma and FMCG have remained a safe bet within the sector play. The important point is that Sector funds need to be timed; entry and exit has to be made at relevant levels and with an underlying rationale. Investments in diversified equity do not require market timing and over a longer horizon, they tend to outperform the benchmark index (the category average could be slightly misleading, since there are more number of funds within the world of large, multi and midcap funds, thereby the number of under-performers would be that much higher which in turn skews the average grossly).

Whilst choosing a sector fund, the emphasis should be on understanding the macro environment and the outlook for the horizon that you propose to be invested in. Where to call it a day and exit? These are the key questions to address before we embark on the herculean task of laying out our funds.

Conclusion & Outlook

For someone who is only starting out on investing in equities, stick to mutual funds and more so, to diversified equity mutual funds. Sector plays are typically for the informed investor who has the ability to time entry and exit appropriately.

The horizon could vary based on the underlying rationale, for eg. If telecom is seeing a lot of action, the benefits will still only pan out over the next 2 years’, Technology could be typical medium term player with the exchange rate scenario working in its favor.

To look at an example, it is interesting to note that infrastructure funds have grossly underperformed consistently over the long haul; the sector under-performing grossly even during the current uptick.

However, the growth prospects for infrastructure continues to be enormous. The huge Indian population along with its growing economy makes it imperative for the government to expand the country’s infrastructure. What are some of the other factors which will take it to the next level? How long will the turnaround and subsequent out-performance take? Over a 3 year horizon, this could be a typical game changer. But, remember to tread with care while you embark on betting on sectors.

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e-mail: Anil Rego

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