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Sector-specific or diversified funds?

The other day, I received an email from a surprised visitor to ValueResearchOnline.com. His surprise emanated from the fact that I had neglected to promote FMCG sectoral mutual funds as the best kind of investment there was. Dhirendra Kumar writes.

india Updated: May 28, 2012 21:41 IST

The other day, I received an email from a surprised visitor to ValueResearchOnline.com. His surprise emanated from the fact that I had neglected to promote FMCG sectoral mutual funds as the best kind of investment there was. His reasoning was simple — over fairly long periods of time, mutual funds that focus on the FMCG sector have performed better — on an average — than diversified sector funds as well other sectoral funds.

The answer to the reader’s puzzlement is something that mutual fund investors need to understand. Over any period of time, the stock markets always favour some sector of the economy more than others. That’s in the nature of markets. Therefore some set of sector-specific funds are always doing better than others. Over the last many years, the favoured sector has rotated through technology, autos, infrastructure, FMCG and perhaps some others too.

In its day, each of these was doing better than diversified equity funds. This is not a coincidence but almost a mathematical certainty. Since diversified funds invest in a number of sectors, their performance is always a weighted average of those different sectors. Therefore, the best of those sectors are individually always doing better than diversified funds.

Therefore, if you look at mutual fund performance at any point of time, it always looks foolish to have invested in diversified funds rather than X sector. However, it’s only when you take a long period into account, you realise that the identity of X keeps changing in unpredictable ways. Not just that, there is a reversion to mean so today’s top sector tends to fall to the absolute bottom. There are plenty of former fans of technology and infrastructure funds who will vouch for this.

Also, there is a more fundamental reason for not dabbling in sector-specific funds. 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 bother yourself with which sector is doing better, then what’s the point of a mutual fund?