Sector mutual funds & their return characteristics
Suparna / 19 Dec 2011
A single sector fund is not a suitable option for all seasons, as sector funds tend to move in cycles. However, they are a good bet for investors with a good knowledge of a particular sector and those who are aggressive enough with a good risk appetite, says Shashikant.
Contrary to common wisdom of not putting all eggs in one basket, a sector fund invests solely in businesses that operate in a particular industry or sector of the economy. Unlike diversified equity funds where they diversify their investments in different sectors which result in lowering the downside risk, sector funds are focused and narrow in terms of asset allocation on a particular sector; and thus are exposed to a higher risk. In shorter periods sector funds tend to outperform the broader market and tend to give better returns.
For example sector funds dedicated to the pharmaceutical sector were underperformers during the bull run of 2007, but in the following year when the market tanked, it outperformed the broader market. If we look at sector funds, they tend to imitate sector indices for obvious reasons.
However, in the long term we do not find any evidence of any sector fund beating the market consistently. There are conditions (mostly economic and sometimes psychological) that favours or hinders sector performance in that particular business cycle. Here is an analysis of the various environments under which sector funds tend to outperform or underperform.
Due to the paucity of the type of sector funds offered by Indian fund houses our analysis will be limited to sector funds such as Banking, FMCG, Pharmaceutical and Infrastructure that covers a major part of the broader market based on market cap. Moreover to capture one entire business cycle we have considered data since 2008 as it gives us the opportunity to study the performance of these funds during turbulence of 2008, the bull phase of 2009, the consolidation phase of year 2010 and again the fall of 2011 (till November end).
Starting with the banking sector, there are only 5 funds that satisfy our criteria and one fund that has consistently outperformed the market in the last 3 years which is the Sahara Banking and Financial Services Fund. However, its lower assets under management (AUM) which is below Rs 25 cr has helped it outperform the broader market. The next best performing fund is Reliance Banking Fund that has managed to give most consistent results and has an annualised return of 31% in the last 3 years. Apart from this no other fund has beaten the broader market consistently. Nonetheless, in CY10, all funds have outperformed the market. One of the reasons for such outperformance is the interest rate.
The banking sector being highly sensitive to the movement of interest rates, these have a large bearing in the performance of banking stocks. It is largely inversely related to the interest rate movements. Although in CY10 the RBI increased the repo rate 6 times totalling to 1.5% of a hike, the outperformance may be attributed to the sharp cut of 1.75% the repo rate in year 2009 and its transmission with a lag effect. This is further substantiated by the fact that in CY11 (till December 12, 2011) the funds have underperformed the broader market and one of the reasons is definitely the 1.5% rate hike in CY10 and 3.75% hike that was effected since March 2010. Going forward we believe that the RBI is almost done with rate hikes and by the 1st quarter of 2012 there might be some cut in key policy interest rates. This will help the banking sector to outperform in the 2nd half of 2012.
Next are the infrastructure sector funds where we have the maximum number of schemes. We analysed 14 funds in this category and found that not a single scheme has consistently beaten the Sensex returns in the last 3 calendar years. What is evident from the data is that in a rising market these funds tend to outperform the market (except 2010) and in a falling market they fall more than the broader market. What this really means is that these funds have a beta of more than 1. This is substantiated in our study of 14 schemes in which eight schemes have a beta of more than 1, and the highest is that of Taurus Infrastructure which stands at 1.41. And therefore it is no coincidence that in CY09 when the market was up by 80%, this fund was the best performer with a return of 123%.
However, there are certain schemes like UTI infrastructure and Escorts Infrastructure that have consistently underperformed the market, whatever the market condition. Moreover, infrastructure sector funds are very positively correlated to business cycles. Looking at the current economic environment (increasing interest rate, contracting IIP, depreciating rupee and worsening crisis in Europe) we believe that the sector will continue to languish for some time and the situation will only improve in the second half of 2012.
For example sector funds dedicated to the pharmaceutical sector were underperformers during the bull run of 2007, but in the following year when the market tanked, it outperformed the broader market. If we look at sector funds, they tend to imitate sector indices for obvious reasons.
However, in the long term we do not find any evidence of any sector fund beating the market consistently. There are conditions (mostly economic and sometimes psychological) that favours or hinders sector performance in that particular business cycle. Here is an analysis of the various environments under which sector funds tend to outperform or underperform.
Due to the paucity of the type of sector funds offered by Indian fund houses our analysis will be limited to sector funds such as Banking, FMCG, Pharmaceutical and Infrastructure that covers a major part of the broader market based on market cap. Moreover to capture one entire business cycle we have considered data since 2008 as it gives us the opportunity to study the performance of these funds during turbulence of 2008, the bull phase of 2009, the consolidation phase of year 2010 and again the fall of 2011 (till November end).
Starting with the banking sector, there are only 5 funds that satisfy our criteria and one fund that has consistently outperformed the market in the last 3 years which is the Sahara Banking and Financial Services Fund. However, its lower assets under management (AUM) which is below Rs 25 cr has helped it outperform the broader market. The next best performing fund is Reliance Banking Fund that has managed to give most consistent results and has an annualised return of 31% in the last 3 years. Apart from this no other fund has beaten the broader market consistently. Nonetheless, in CY10, all funds have outperformed the market. One of the reasons for such outperformance is the interest rate.
The banking sector being highly sensitive to the movement of interest rates, these have a large bearing in the performance of banking stocks. It is largely inversely related to the interest rate movements. Although in CY10 the RBI increased the repo rate 6 times totalling to 1.5% of a hike, the outperformance may be attributed to the sharp cut of 1.75% the repo rate in year 2009 and its transmission with a lag effect. This is further substantiated by the fact that in CY11 (till December 12, 2011) the funds have underperformed the broader market and one of the reasons is definitely the 1.5% rate hike in CY10 and 3.75% hike that was effected since March 2010. Going forward we believe that the RBI is almost done with rate hikes and by the 1st quarter of 2012 there might be some cut in key policy interest rates. This will help the banking sector to outperform in the 2nd half of 2012.
Next are the infrastructure sector funds where we have the maximum number of schemes. We analysed 14 funds in this category and found that not a single scheme has consistently beaten the Sensex returns in the last 3 calendar years. What is evident from the data is that in a rising market these funds tend to outperform the market (except 2010) and in a falling market they fall more than the broader market. What this really means is that these funds have a beta of more than 1. This is substantiated in our study of 14 schemes in which eight schemes have a beta of more than 1, and the highest is that of Taurus Infrastructure which stands at 1.41. And therefore it is no coincidence that in CY09 when the market was up by 80%, this fund was the best performer with a return of 123%.
However, there are certain schemes like UTI infrastructure and Escorts Infrastructure that have consistently underperformed the market, whatever the market condition. Moreover, infrastructure sector funds are very positively correlated to business cycles. Looking at the current economic environment (increasing interest rate, contracting IIP, depreciating rupee and worsening crisis in Europe) we believe that the sector will continue to languish for some time and the situation will only improve in the second half of 2012.
Two sectors that are performing well in the current volatile situation are healthcare and FMCG. These sectors are considered to be defensive and tend to perform well in volatile or failing markets. If we look at the year till date (YTD) performance, we find that though the Sensex is down by 23%, the BSE FMCG is up by 7%. When we look at the performance of the FMCG schemes; ICICI Prudential FMCG and Magnum FMCG they both have clearly outperformed the Sensex by huge margins of 39% and 35% respectively on a YTD basis.
Similar is the case with healthcare funds that have managed to beat the broader market index though not as good as FMCG. For example Reliance Pharma Fund has yielded a negative return of 10% on a YTD basis compared to a negative 13% returned by the BSE Healthcare index and a negative 23% returned by the Sensex. In the current unpredictable environment one can opt for such funds as they provide minimum risk.
From the above discussion it is clear that a single sector fund is not suitable for all seasons. They move in cycles and every cycle throws its own winner and loser. They cannot outperform on a consistent basis and fetch better returns for only shorter periods. Hence we suggest only aggressive investors with good knowledge of sector dynamics should go for such funds. In addition to this, sector funds should not be a part of your core portfolio and should not be more than 10%-20% of your total portfolio depending upon the risk appetite of individual investors.
Similar is the case with healthcare funds that have managed to beat the broader market index though not as good as FMCG. For example Reliance Pharma Fund has yielded a negative return of 10% on a YTD basis compared to a negative 13% returned by the BSE Healthcare index and a negative 23% returned by the Sensex. In the current unpredictable environment one can opt for such funds as they provide minimum risk.
From the above discussion it is clear that a single sector fund is not suitable for all seasons. They move in cycles and every cycle throws its own winner and loser. They cannot outperform on a consistent basis and fetch better returns for only shorter periods. Hence we suggest only aggressive investors with good knowledge of sector dynamics should go for such funds. In addition to this, sector funds should not be a part of your core portfolio and should not be more than 10%-20% of your total portfolio depending upon the risk appetite of individual investors.
If you want to stay updated with the share market news today, keep a close watch on the indian stock market today with real time movements like sensex today live and overall stock market today trends. Investors tracking ipo allotment status, ipo news today, or the latest ipo india can also follow daily updates along with bse share price live data. Whether you are learning how to invest in stock market in india, preparing for a market crash today, or searching for the best stocks to buy in india, insights on top gainers today india, top losers today india, trending stocks india and long term stocks india help in making informed investment decisions.