Equity Mutual Funds Categorization (Part-B.2)

By | November 23, 2018


9. Sectoral/thematic funds -: 80 percent of the total assets of these equity mutual fund schemes will be invested in a particular sector or theme. These equity mutual are not suited for retail investors as they carry huge sectoral/ theme overexposure risk. The Diversified Equity Mutual funds is a better option than sectoral equity mutual fund/thematic fund.

  • Sectoral/thematic Equity Mutual funds are risky products: The sectoral and thematic equity mutual funds carry greater risk as they invest in some specific sectors/themes. Since a pharma equity mutual fund will invest in pharma stocks while a banking fund will invest in financial services stocks.

Thus, a specific theme based fund like Infrastructure or financial services or consumption will invest in many sub-sectors of that particular theme. Ex. Infrastructure fund will invest in road companies, power companies, equipment supplier, equipment financiers, capital goods, engineering etc. Hence, these funds carry the risk of severe outperformance and underperformance. Ex. Infrastructure funds did very well in 2007 but they have not been able to beat benchmarks since the 2008 crash.

  • Sectoral/Thematic funds need good timing: These are suited for people who can ride the economic cycle and know which sectors will do well during various time frames of economic recovery and recession. Since, timing the markets, and predicting the sectoral performance in the economy is a very hard task which should be avoided. Themes and sectors can change very rapidly in today’s complex and dynamic world. Thus these funds should be used with caution.
  • Diversified fund vs sectoral/Thematic fund: Also, a diversified equity mutual fund can play the sector/theme better than the sectoral fund. It has an implicit play of thematic fund built into it. Whenever the fund manager thinks that he needs to increase/decrease exposure in some particular sectors/ theme, then he automatically adjusts his portfolio towards that sector/theme. Eventually, an investor may have a diversified fund in his portfolio.

EX. The fund manager may have large exposure in Infra in the diversified mutual fund. If the same investor has an infrastructure fund in his portfolio too. This will lead to duplicity in the account with more risk built into the portfolio. Thus a diversified mutual fund scores much well over a sectoral/thematic fund.

10. Contra fund -: These equity mutual funds takes contrarian calls on stocks and sectors and will invest in beaten-down stocks and sectors. It is called contrarian investing too.

Ex. A contra fund may invest in telecom companies like Bharti, idea etc thinking that these stocks are at rock bottom. Sooner, the sanity will come and there will be a revival of earnings growth in these stocks. It is a type of value fund which takes a contrarian view on markets.

11. Value Fund -: A value fund is one fund which invests in value stocks. This fund invests in companies which are trading below the intrinsic value and markets are giving them low valuations. Ex: A Value fund will invest in low P/E, Low P/B stocks. Low EV/EBITDA seeking a margin of safety and valuation comfort. They don’t want to overpay in terms of valuation multiples.HDFC Capital Builder Value Fund, IDFC Sterling Value Fund-Regular Plan Growth, Invesco India Contra Fund, Tata Equity PE Fund-Regular Plan. These are some of the top 4 performing equity mutual funds in the value category.

The beauty of a value fund is that it is a low risk and moderate return equity product. Thus it suffers minimal drawdown during corrections or market falls. But it also underperforms during the market rises and euphoria. So, its suited for people with moderate risk appetite. So, in nutshell, the value funds do very well during bear markets and do ordinarily in bull markets.

Ex. Icici Pru value discovery fund avoided realty, infrastructure stocks in 2007 citing valuation discomfort and underperformed significantly in 2007. The market crash of Jan 2008 saved the fund from significant fall as it had minimal exposure to high beta and high valuations sectors like realty and infra. S. Naren of ICICI Prudential Mutual Fund is one the star rate value investor and fund manager in India.


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