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How often should you switch sectors

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For any investor, when it comes to choosing between diversification and concentration, it works as a double-edged sword. Concentration is like putting all eggs in one basket. If the stocks or the funds don't perform well or lose money, as an investor with a concentrated strategy, you would suffer losses. On the other hand, with a diversified portfolio, the good performance of some may be offset by the bad performance of the others, and hence you would probably end up getting an average return in your portfolio.


So financial planners and advisors say that you need to cut a balance between the two approaches. And such a balance could be achieved by switching from one sector to another at the opportune time, that is rotate the stocks or the sectors, although such a rotational strategy should not be undertaken very frequently. Depending upon your financial plan which is based on your risk taking ability, you may consider concentrating on 4-5 sectors and then switch from those 4-5 sectors to another 4-5 over a few years. But not all such switches should happen at the same time.


If you are invested through the mutual fund route, one of the main factors to consider for such a switch is the impact cost for the fund, which again could be the aggregate of the impact costs of the stocks in its portfolio. Usually, it is seen that funds which are invested in large cap stocks have low impact costs. Compared to this, medium and small-cap stocks come with higher impact costs. Impact cost is the price one pays in terms of the marginal higher price that the buyer has to pay in case his/her buy order is bigger and such an order can have some influence on the prevailing market price of the stock. Impact cost could also be incurred when a stock is sold, which is in terms of lower price realized by selling a large order.


One of the other main factors to consider while deciding on a sectoral switching strategy through the mutual fund route is how much time the fund manager takes to go from one sector to another. Suppose, the fund holds stocks worth about Rs 50 crore of one company and the daily turnover in counter is about Rs 1 crore. So the average time that will be taken to sell all the stocks of the company is about two and half months (if we consider 20 trading days in a month) without having any major impact on the stock's market price. The next step for the fund manager would be to deploy this money into the stock or stocks that he/she intends to invest in. Here again the fund manager has to take care of the impact costs.

Another factor to consider would be the track record of the fund manager in managing such a fund. "Often fund managers take contrarian calls on some sectors, invest in those sectors which are not performing well and then wait for the tide to turn in favour of these industries. Thus at times sector rotation funds tend to underperform for some time and investors should have the patience to remain invested in such times.

 

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