Rule: One should have a long-term horizon when investing in equity mutual funds.
Exception: When it comes to sectoral funds, it is better to book your profits after 1-2 years because sectors tend to move in cycles. A longterm view is advisable when you are investing in index and diversified equity funds.
11.8% has been the annualised return from the average tech fund in the past five years. In the same period, diversified equity funds gave annualised returns of 22.8%.
68.1% has been the return from the average banking fund in the past six months. During the same period, diversified equity funds gave returns of 54.5%.
Sectoral mutual funds allow investors to have a focused exposure to equities. However, these funds are more volatile than diversified equity funds because their fortunes are linked to the performance of just one sector. Since sectors tend to move in cycles, each year throws up new leaders. As the table below shows, a sector that outperforms in a given year is likely to lag behind in the following years, and vice versa.
How sectors have fared since 2005
Yearly returns from BSE sectoral indices and the Sensex in the past five years.
The IT sector outperformed in 2005 and 2006, but slumped in 2007 and 2008. Pharma underperformed for three years, but lost the least in 2008. The auto sector performed poorly in 2007 and has raced ahead in 2009. Note that during this jostling, the diversified Sensex continued to give decent returns, except in 2008.
You can use the cyclicality of sectoral mutual funds to your advantage. Buy funds that invest in sectors which are down right now. Over the next couple of years, these sectors could bounce back. That would be a good time to book profits and switch to the worst performing sectors.
