Part II: Theme funds are risky, but they can make money
Investors can be suckers.
Despite a wide array of well-performing funds to choose from, they will flock to new fund offering because they don't want to miss the latest 'theme' or 'opportunity'.
Fund houses are aware of this and thematic funds have done a bang-up job of attracting money. Currently, there are around 27 thematic funds accounting for around Rs 12,000 crore in assets under management.
Thematic funds will choose an investment theme based on a broad social or economic trend. It could be anything from financial services to infrastructure to socially responsible investing. This may sound very structured and well thought out. However, what you, as an investor, must realise is that your current funds may have sufficient exposure to the very sector and stocks that the theme is espousing.
Here are four simple questions you need to answer to figure out what you really need and what you can avoid.
Does my diversified equity fund have an identical exposure?
For the sake of argument, let's say you are already invested in a diversified equity fund like DSPML Equity Fund.
But the temptation to also invest in a fund like ICICI Prudential Services Industries could be strong. After all, it delivered a stellar 77.56 per cent return over a one-year period (as on July 6, 2007). A look at the portfolio reveals 22.61 per cent in technology and 15.55 per cent in financial services. By itself, that is fine.
But since you are already invested in DSPML Equity Fund, you have an almost identical exposure to these very two sectors: Technology (21.95%) and financial services (11.67%).
Does it make investing sense? Are you comfortable with this much of exposure to the same sectors? Are you looking at being more diversified in your investing?
Let's say you get tempted with another fund. J M Basic's one-year return of 81.20 per cent (as on July 6, 2007) sounds irresistible.
Now, this makes more investing sense when coupled with DSPML Equity Fund. Sectors like financial services, pharma, technology, textiles and chemicals that DSLML Equity has invested in, will not be found in the J M Basic portfolio.
The top three sectors at J M Basic (construction/ basic engineering/ metals and metal products) are not the top three at DSPML Basic (technology/ energy / financial services).
So, by combining these two funds in your portfolio, you have diversified your exposure and risk and not increased them.
Does the thematic fund overlap with my sector fund?
At one time, sector funds were heavily courted till they lost their charm. Now, thematic funds woo investors. The latter are not as restrictive and their theme could well run across many sectors.
Let's say you invested in DSPML Technology.com. Your investment would have paid off big time since the one-year return would be 90.62 per cent (as on July 6, 2007).
To balance it out, you decide to invest in UTI Services Sector Fund. Since the objective of the fund is to invest in companies engaged in banking, finance, insurance, education, telecom, travel and entertainment, it does not appear to overlap with tech stocks.
But the portfolio throws up a different scene. UTI Services Sector has a high exposure to technology (32.18%) and services (15.73%). While DSPML Technology.com has 75.51 per cent invested in technology and 15.64 per cent in services.
So, individually, the fund may make sense. But, when looked at in conjunction with another current holding, it loses its broad appeal.
How much of flexibility does the fund's objective have?
Sometimes, it is the fund's objective that ties the fund manager.
In such cases, the fund becomes a very concentrated and risky proposition. Take Tata Life Sciences and Tech. On the face of it, it looks extremely promising and investors would probably feel they cannot go wrong with these two sectors. But, should the tide turn, the impact can be messy. The fund has invested more than 40 per cent in technology and 35 per cent in healthcare. A 75 per cent exposure to two sectors will give a lot of investors sleepless nights.
Or take the Standard Chartered Enterprise Equity Fund. What if the appetite for Initial Primary Offerings disappears? What about periods when there are no IPOs being launched? The premise of the fund is to make money by subscribing to an IPO and selling when it lists at a premium. Quite a bold assumption.
The broader the objective, the easier it is for the fund manager to manoeuvre his stocks should a few sectors get hit.
Am I clear on where the fund is investing?
Funds may go by the same theme, yet their individual focus could differ.
The infrastructure theme is well suited to make a point. There is no boundary to the definition of an infrastructure fund, a prime reason why it is not a sector fund. The predictable sectors will be cement, energy, construction real estate, capital goods and engineering. But banking and technology would also be included by some funds after all, according to their understanding, building a banking network is also part of infrastructure development.
Don't go by the conventional names too. Tata Infrastructure, UTI Infrastructure, Sahara Infrastructure, ICICI Prudential Infrastructure, CanInfrastructure and Birla Infrastructure are the obvious infrastructure funds. But not the only ones.
Principal Infrastructure & Services Industries invests in stocks that belong to the infrastructure and service industries. DSPML T.I.G.E.R. is an acronym for The Infrastructure Growth and Economic Restructuring. JM Hi Fi has a long and winding objective but stands for Housing, Infrastructure and Financial Services.
Or, to take another example, you may want to invest in some consumerism driven themes. But funds seeking to ride the consumer wave have portfolios identical to those with the services theme. The top three sectors for both these themes read as: technology/ telecommunication, services and financial services. So, if you have already invested in a fund with a services theme, hold on.
Listen up!
Don't fall for the marketing gimmicks of mutual funds. Or, to put it bluntly, don't be a sucker for their sales spiel. Be discerning.
All the funds mentioned here are used on a purely illustrative basis. None of them are recommendations.