Limit Holdings In Sector Funds

Q. What is the difference between sectoral and thematic funds? I have DSPML Tiger Fund, Reliance Power and BSL Special Situations Fund. Are these sectoral or thematic funds? Please explain.

Prakash, Bhopal

A. Some equity schemes have the mandate and philosophy of concentrating their investment in one industry sector. In the past we have seen many such schemes, and these have concentrated on industry sectors ranging from IT, pharma and FMCG to power, infrastructure, banking, entertainment, capital goods and natural resources. Thematic funds tend to have a philosophy of investing. This category will include funds such as Special Situations Fund, Contra Fund, Emerging Business Fund etc. At times it seems that there is a very thin line between the two especially when we come across themes such as MNC or lifestyle or basic industries as the investment mandate.

There are pros and cons to investing in sector funds. I have noticed that sector funds are often introduced at the height of a fad – as a result, one ends up getting attracted to the sector / scheme at high valuations. When the fad fades away, the fall is severe and most retail investors end up losing money. It is not that the underlying businesses have closed shop; what would have happened is that their shares would have gone way above fair valuations and hence the fall-back to reality is steep. The way to enjoy a sector fund is to have limited holdings in it – maybe up to 20 per cent of the portfolio and not more unless one can take the sell decision on time. Since the holdings are concentrated in one sector, if the sector’s fortunes are on an upswing, the investor tends to make higher gains than the broad index.

A thematic fund such as the Special Situations Fund that you have, aims to identify stocks of companies that are undergoing some kind of change that will improve its stock valuation. These changes could be a merger, acquisition, turn-around from sickness, research about to bear fruit, share buy-backs and such other corporate actions. Such portfolios are difficult to evaluate on a regular basis since they do not bear much co-relation with the overall market on a upswing, but fall as much in a downswing. BSL Special Situations Fund is fairly new to make a fair evaluation, yet. But both these types should have a limited presence in a portfolio due to the higher risks associated with their performance.