Mutual Fund: Diversified or Sectoral?

One of the key decision points for retail investors while investing in mutual funds is which category to go for - diversified or sectoral funds. Diversified equity funds invest in shares of companies across different industries or sectors, thus fund managers has the freedom to pick shares of any company from plethora of sectors. While sectoral funds focuses in one specific sector, fund managers gets to pick shares of companies from that specific sector only. There are a many sectoral funds – Power Funds, Infrastructure Funds, Technology Funds so on and so forth.

The decision becomes trickier because in any given time one or other sector will be doing better than the overall economy and corresponding sectoral funds outperforms the diversified funds. In this article we will explore which of these two categories is better for retail investors in the long run. First let us look into the primary reasons why people invest in equity through mutual funds; as discussed in an earlier article key reasons are

• Inadequate expertise in equity
• Inadequate bandwidth to track
  

Now let us revisit these same points with regards to sectoral funds. With inadequate expertise or knowhow how would one pick the right sector? Prospect of a sector is dependent on many factors like cyclic nature of some sectors (like metals), supply demand scenario, regulatory changes, rupee appreciation (like IT). With inadequate bandwidth and expertise how would one know when a sector will go in/out of fashion and enter/exit related sectoral funds? Thus sectoral funds contradict the very reasons people invest in mutual funds in the first place.

Moreover, in sectoral funds, fund managers are constrained to look for quality stock from a handful of choices in that sector. Even if a specific sector has better prospect it is not necessary that all and sundry in that sector will prosper. Besides a conducive environment, prospect of a company also depends on many other factors like management quality, product/service quality, strategic decisions etc. After all not all IT companies in India has gone on to become TCS, Infosys or Wipro even though overall IT sector had a dream run in the last decade. Thus it’s a tough task to identify more than 4/5 winning stocks in a sector.

  
But are sectoral funds “all bad and no good”? It depends how you leverage them. Sectoral funds are high risk bets which can give high return when used properly. Once core of a portfolio is built around diversified and balanced equity funds, based on risk appetite sectoral funds can be used to accelerate return in short bursts.  It’s something like batting power play in cricket (Ok, that’s a rough analogy from a cricket buff!!)

Key takeaway

• Diversified funds invest in shares of companies across different industries or sectors while sectoral fund invest in a specific sector.

• Diversified funds are relatively safer than sectoral funds. Diversified funds are for long term, while sectoral funds are for short term.

• Diversified funds should be part of our core portfolio, while based on your risk appetite use sectoral funds to accelerate return in short bursts.

• Track sectoral funds more frequently and book profit whenever your target is reached.

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