Moneycontrol Pro Panorama | Rethinking sectoral funds

Investors who generally get trapped in these schemes are generally the same ones who buy stocks on tips.

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Warren Buffett has strongly advocated against investing in IPOs. His logic is that these are orchestrated to achieve the best result for selling investors. He noted that these deals are negotiated to achieve the best price for the sellers and put buyers at a disadvantage. We have seen this to be true even in Indian markets where companies and their advisors take advantage of the market euphoria to push their IPOs at high valuations.

The same is also true in the mutual fund industry. Asset management companies take advantage of the euphoria in a sector or theme to launch a fund. More often than not, these funds hit the market when stocks in the sector are near their peak.

A media report says that more than a third, or 50 out of 145 such funds, are trading below their net asset values (NAVs). Quoting Value Research data, the report says mutual funds have garnered over Rs 72,000 crore by way of equity NFOs this year, of which 85 percent is from sectoral/thematic schemes.

A sector or thematic fund is focused on a handful of stocks that generally move in tandem. Mutual funds are expected to offer investors the benefit of diversification which sectoral/thematic schemes fail to address.

Investors should realise that sectoral and thematic schemes are cyclical in nature and generally have a short life as compared to the broader market. They move in sharp spurts, as we saw in defence stocks, where the fundamentals overshoot the price. It then takes a long time for valuation to catch up with price.

Investors who generally get trapped in these schemes are generally the same ones who buy stocks on tips. Furthermore, as AMCs pass on higher commission to the distributors and other sales agents for NFOs, their self-interest drives sales over that of the investor.

Sectoral funds managers have to stay invested in the stocks -- they can reduce weightage -- irrespective of the cycle they are in. The fund manager of an actively managed fund can reduce his stake, but cannot completely come out of it. But in a passive fund, the investor is stuck with stocks of the sector irrespective of the market and business cycle.

If investor interest is paramount, SEBI and other authorities need to revisit these high-risk sectoral and thematic schemes. Any fund manager of a diversified fund worth her salt will be adding more weight to a sector that is performing provided fundamentals are supporting the stocks.

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