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Diversify across assets and sectors even in Mutual Fund Investing

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Investors should diversify to minimize the total risk in their portfolio. The main logic behind this is all sectors, or assets, do not perform well or badly at the same time. So, if one is diversified, it would insulate the portfolio from what is known as concentration risks. Like an investor can diversify across asset classes, he/she can diversify within the equity portfolio or even within the mutual fund portfolio.


In the context of mutual fund, the decision of a fund manager to shift portfolio from one sector to another is called sectoral rotation. This involves a few things on the part of the fund manager. Those are identifying the future winners and getting rid of the nonperformers. And it also entails some costs on the part of the scheme in the form of impact costs of buying and selling of securities, and brokerage paid for such transactions. So, sectoral rotation could come at a higher cost than the pure buy and hold strategy for long term investors. At times, a fund manager may find that a sector has performed over a period of 3, 4, 5 years and may not replicate the same robust performance over the next few years, he/she may decide to sell the stocks from this sector and use the money so realized to invest in stocks from another one or two sectors which could be winners over the next 3, 4, 5-year period.

Here, the main aim of the fund manager is to make smart gains for investors from the fact that not all sectors perform equally well at the same time. Also the fund manager may have seen some smart opportunities which could benefit investors and, hence, sells those which may not be the winners and gets into those sectors which may. However, investors should be able to guard themselves from those fund managers who get in and out of some sectors too frequently, because such a strategy would entail very high costs to the investors in the fund.

From the financial planning perspective, however, sectoral rotation per se should not be one of the objectives for a portfolio, planners and advisors said. They say that the financial planner and advisor should independently be able to look at the funds and then decide whether to advise any or more than one fund to their clients. Also, since each sector comes with a different level of risk, financial planners and advisors should be able to judge and then map the suitability of each scheme to each of client. Each and every plan should have different fund allocation and since sectoral and sectoral rotation funds often have substantial fluctuation, one should advise these funds after due consideration.

Financial planners and advisors also said that every investor who has invested in sectoral rotation funds and have seen underperformance over a few years should have a clear strategy of getting out of such funds. This also holds true if an investor has invested in the stocks of a few sectors directly but is stuck with underperformance.


Often, it is seen that out of say 10 sectors, 4-5 have performed very well while the rest have performed badly. In such cases, investor usually becomes emotional and sells the winners early in portfolio life cycle while holding on to losers in the hope that they would come back above water. Investors are usually averse to get out of their losers quickly, a phenomenon which in behavioural finance is called the disposition bias.

The fact is some time certain investments could be like a boat with a hole. If you don't jump out of it at the right time, and try to salvage whatever you can, in future the entire boat might sink, and the loss could be much higher.

 
Financial planners and advisors usually review a portfolio every six months to check if the portfolio is as per the original plan on track or has veered off track. And while reviewing a portfolio, the two most important things the planners and advisors look at are the performance of the funds in the portfolio and the taxation policy. At times it is seen that a change in the government's taxation policy, especially after the annual Budget, could impact the performance of some types of funds. In such a situation, a review of the funds and their future performance becomes necessary.

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