How Much Should You Invest In Exotic Funds?

Long-term investors rely on the potential of equity and equity-oriented funds to generate positive real rate of returns. However, only those investors who have the patience and perseverance to withstand the periodic volatility benefit from the true potential of these funds. It is also important to invest in different segments of the market by choosing the right combination of funds through different investment philosophies and strategies. Simply put, these funds allow investors to earn better than market returns over time. [EasyDNNnews:PaidContentStart]

The key issue, therefore, is how to select the right mix of funds in the portfolio. Ideally, you should begin with diversified funds as they invest in a wide range of stocks across various sectors. Once you have built a reasonably large Equity Funds portfolio and learnt the nuances of equity investing over time, you may consider investing a part of your investments in categories such as contra and value funds, sector as well as thematic funds. Here too, the key factors would be to carefully select the right mix of funds from these categories and decide the extent of the exposure to such funds based on your risk profile. 

While most investors are familiar with plain vanilla equity funds, the mystique surrounding some of these exotic funds often creates a dilemma in the minds of investors about their role in the portfolio. A better understanding of these funds can go a long way in getting the best from them as well as ensuring that their inclusion in the portfolio does not take you beyond your risk-taking capacity. Here is what they offer: 

Sector Funds : Sector funds are highly focused in that their investments are aimed at a particular industry. The basic idea is to enable investors to take advantage of industry cycles. Since these funds ride on market cycles, they have the potential to offer good returns if the timing is perfect. 

However, sector funds should constitute only a limited portion of a portfolio as they are much riskier than a diversified fund. As these funds invest in one industry or sector, they do not provide the downside risk protection available in a diversified fund. 

Thematic Funds : Thematic funds focus on structural as well as cyclical factors that play an important role in the economy. T hey are more diversified than sector funds as they look for trends that are likely to result in out-performance of certain sectors or companies. Besides, by incorporating the macro environment in the investment process, a thematic fund adds value and protects investments from adverse movement in the macro environment. 

On the negative side, the market may take more time to recognise the views of the fund house with regard to a particular theme that forms the basis of launching a fund. Hence, there could be long periods of poor or under performance. 

Contra Funds :  A contra fund is actually a contrarian fund that bets on unrecognised value of out-of-favour companies. T he rationale for following this approach is the belief that sooner or later the market will realise the true value of these companies and that would result in better performance of these stocks. These funds are ideally suited for investors looking for an option that has the potential to perform in different market environments by exploring both value as well as growth opportunities. 

Value Funds : A value fund focuses on stocks that are deemed to be undervalued. In other words, a fund manager following value investing tries to take advantage of the market inefficiencies that allow him to buy stocks at less than their intrinsic value. 

Even though there is a case for an established investor to include some of these funds in his portfolio, it will be prudent to have a limited exposure to begin with. Your ‘bread and butter’ funds in the portfolio should always be diversified funds. 

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