Whenever
the equity markets are on the rise, schemes of a particular fund house are
outperforming its peers or when a particular mutual fund scheme or a particular
sector is generating extra ordinary returns, a very unique set of investors
flock the equity markets.
Their
uniqueness is in reference to their belief that the equity markets will always
be on the rise, a sentiment contrary to empirical evidence since the beginning
of the equity markets.
It is very easy and simplistic to refer to them as optimists when in reality, greed is the trait in play.
What is a Sectoral Mutual Fund?
A
Sectoral Mutual Fund as the name suggests invests only in one particular
sector.
It is
less diversified than a Thematic Mutual Fund since it is restricted to just one
particular sector.
Think
of Sports as a theme and various disciplines like Football and Basketball like
sectors. Sports constitute both Football and Basketball but Football does not
constitute Basketball and Basketball does not constitute Football.
In
the same manner a Thematic Mutual Fund constitute various sectors but it is not
necessary that various sectors fall within the same theme.
Think
of a Pharma mutual fund scheme, it can only invest in companies belonging to
the pharmaceutical sector.
The Background
Prior
to the market crash of 2020, the IT sector as a whole was underperforming for
several years now.
This changed post
the market crash 2020.
The sector had
renewed hope with IT services in demand with most work shifting to online mode.
This meant more
work for the sector but at reduced costs which in turn meant higher profits.
The sector all of a
sudden was staring at a turnaround which was reflected in the quarterly numbers
as well as their stock prices.
Investors lured by the
recent outperformance poured in IT sector funds at a healthy rate both in 2020
as well as 2021.
Reality Sinks in
Both in 2020 as
well as in 2021, IT sector funds as a whole generated more than 50% returns.
So far in 2022, the
IT sector is generating negative returns.
This has led to the
obvious, investors redeeming a good chunk of their investment in IT sector
funds and some even at a loss.
The entire cycle
lasted for around 2 years, a negligible time period when it comes to equity
investing.
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The Cause-Effect loop
Any sector will go
through various cycles periodically, the IT sector is no different.
When things were buoyant,
IT companies were posting healthy numbers.
Things changed in
the first half of 2022 due to the Ukraine-Russia conflict along with stricter
Covid related restrictions in China.
Both these factors
led to higher inflation rate globally with the US for example having its
highest inflation rate for around 40 years.
Equity markets do not take a liking for uncertainty.
The US is the major source for Indian software companies but
the US itself is going through a major inflation crisis which in turn has
affected sales.
The IT sector which was hiring at a healthy rate post the first
lockdown is now being plagued by higher attrition rates and lower job openings.
Post Mortem
First time
investors motivated by greed during a buoyant market phase usually are also the
first to exit during a market correction, the reasons are self-explanatory.
For any thematic or sectoral fund,
entering and exiting at the most profitable time on a consistent basis is of paramount
significance which is not possible.
In the long run, IT
sector funds are no different than other equity mutual funds when it comes to
returns but they can be extremely volatile in the short run and it is
unfortunately during this very short cycle that most people enter and exit
leaving them with little to no gains.
IT sector stocks
usually have the second or third largest allocation in the most popular categories
like multi cap, flexi cap, large cap, mid cap and large & mid cap fund
schemes, therefore one needs to gauge if the addition of an IT sector fund separately
adds any meaningful value to the overall portfolio.
If you are an
investor then invest and if you are a trader then trade but do not try to trade
where and when you should be investing since that never ends well.
Should you invest in a Sectoral Fund?
If you do, consider the following points before diving in:
Minimal Exposure
A sectoral mutual fund should have limited exposure in your
mutual fund portfolio.
It should be a part of your satellite portfolio and never be
a part of your core portfolio.
Understanding the sector
Only invest if you do and can understand the sector well.
This involves being able to understand reasons behind past
performances as well as the ability to forecast future prospects.
This does not involve investing blindly on past
performances.
Long Duration
You should consider a sectoral mutual fund scheme only if
you are ready to stay invested for the long haul.
This means staying invested for seven years or more.
This is important since sectors go through various phases
and cycles.
You should be able to go through all phases and cycles to
make meaningful returns.
Entering the fund
As previously mentioned, sectors go through various phases
and cycles.
If you enter a thematic or sectoral mutual fund scheme during a peak,
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