Look Before You Leap

The Sensex has once again crossed the 17,000 level. It can be considered significant, if not decisive, considering that the market has been moving sideways for sometime. However, there are conflicting views about what the market has in store in the near and short term. While a section of experts believe that a correction is just around the corner, another section feels that the stock market is gearing for a major move upward. A situation like this can unsettle a lot of investors and pose a dilemma as to what their next move should be.
First, let us address the issue of correction in the stock market. It is very difficult to predict as to when this liquidity driven rally is going to come to a halt, if at all. Moreover, considering that the long-term prospects of the stock market look positive, timing the market may not be a great idea. Remember, with any investments there are two key decisions to be made. The first is when to buy and the second is when to sell. Obviously, the difficult one is to know when to sell.

Any attempt to book profit with an intention to reinvest at lower levels is nothing but trying to time the market and that is not a great idea. While booking profits periodically can be a useful exercise for the long-term health of the portfolio, relying on the market timing to do so may not always be a smart thing to do. Therefore, one needs to follow a proper strategy to book profits. The right way to book profits is by way of rebalancing the portfolio to bring the asset allocation back at the original level. This will ensure that one remains invested in equity at all times.
While doing so, one needs to consider one’s risk profile and the impact the current valuation of equity funds has had on the original asset allocation. Another way for a mutual fund investor to book profit periodically is to opt for dividend payout option. This not only ensures periodical profit booking but also provides an opportunity to rebalance the portfolio without any tax implications.
Coming back the current market situation, while some investors are grappling with indecision about whether to book profit or not, there are those who are ready to take their portfolio beyond their accepted level of risk in the hope of making a quick buck. Some of the aggressive funds that have done well in the recent past look too tempting to resist. One such category of funds is sector funds. Though these funds can be a great addition to a diversified portfolio both in terms of improving overall returns as well as increasing exposure to those industries that may be under-represented in the existing funds, they may not be suitable to all investors.
Besides, it is advisable that one reviews one’s portfolio to make sure that one is not investing in a sector in which there is already a sizeable exposure through other funds. The basic idea of sector funds is to enable investors to take advantage of industry cycles. Since sector funds ride on market cycles, they have the potential to offer good returns if the timing is perfect. However, as sector funds invest in one industry or sector, they do not provide the downside risk protection available in a diversified fund. Further, many a time investors end up investing in sector funds when the sector is near its highest prices.
Generally, sector funds should constitute only a limited portion of a portfolio, as they are much riskier than a diversified fund. That’s why only those who have an adequately diversified portfolio and the risk appetite to absorb extreme movements should consider investing in these funds. One can adopt different strategies to reduce the risks generally associated with investing in sector funds. One such strategy is to have small exposure in 3-4 sectors rather than having a huge exposure in one sector.
[PAGE BREAK]
However, before investing in a sector fund one needs to assess certain key criteria that may be important to one’s profile. These are:

• How diversified is the existing portfolio?
• What is the risk taking capacity and the temperament to tackle the volatile nature of sector funds?
• Does one have the capacity to hold a sector fund for the long-term if required and to curb the urge to switch frequently from one sector to another?
• Is one willing to invest some time and effort to keep up with the industry developments in a chosen sector?