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Sectoral blues - Views on News from Equitymaster
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  • Oct 23, 2000

    Sectoral blues

    Investors who had invested in the heydays of sectoral funds find themselves wishing they had invested in a diversified growth fund, or for that matter even in a bank or company fixed deposit. This is mainly because sectoral funds have underperformed other investment avenues.

    Sectoral funds (FMCG, pharma and software) were launched in the bull run last year that centered round the golden triangle sectors – fast-moving consumer goods (FMCG), pharma and software. Stocks in these sectors hogged all the limelight and investors refused to look beyond them.

    Investors apart, fund houses also refused to look beyond them. So we had fund houses launching FMCG funds and pharma funds in addition to software funds. This was in stark contrast to the prevailing trend of launching diversified growth funds. A sector fund in itself is against the canons of a mutual fund, which relies heavily on diversification to counter market and economic upheavals. With a sectoral fund, a fund manager imposes constraints upon himself to stick to a group of stocks within a sector regardless of the mood in that sector. In other words, he is not at liberty to make investments in another sector as this would defeat the investment objective of that sectoral fund.

    So while FMCG, pharma and software funds did well for a while, it wasn’t long before harsh realities took over and the old golden triangle was replaced with the new guard – TMT (technology, media and telecom). Of the old guard, only software commanded buying interest with FMCG and pharma taking a backseat. Investors realised the growth potential or the lack of it of these stocks, vis-à-vis software, and shunned them completely.

    Open-ended, IT Funds NAV
    IL&FS eCOM Fund (Gr) 5.2 2.1% -13.3% 0.0% -61.6%
    Pru ICICI Tech. (Gr) 5.1 0.8% -12.3% 0.0% -47.9%
    Tata IT Sector Fund 9.4 0.0% -17.4% -0.4% 16.3%
    Alliance New Millenn (Gr) 7.4 -0.4% -14.1% 0.0% -51.3%
    Magnum Sector Funds-IT 12.9 -0.6% -17.7% 0.6% 78.3%
    Birla IT Fund (Gr) 15.1 -2.7% -17.4% -16.9% 8.9%
    Chola Freedom Tech (Cum) 12.8 -3.5% -15.1% -18.9% 8.7%
    K P Infotech (Gr) 23.9 -3.6% -16.1% 18.9% 111.3%
    K Tech 6.1 -3.7% -16.9% 0.0% -22.4%
    DSP ML Tech.com (Gr) 6.9 -3.9% -16.2% 0.0% -19.7%
    K P Internet Opport.(Gr) 6.4 -4.6% -17.3% 0.0% -33.0%
    UTI Sector- Software 16.9 -5.1% -20.7% 6.6% 26.5%

    Only Kothari Pioneer Infotech Fund and UTI Software Sector Fund have registered positive growth over the last 12 months. KP Infotech is the only sectoral fund in our sample to post double-digit growth over the last 12 months. The last 6 months have been dismal for IT funds which robbed them of all growth during the TMT bull run.

    Open-ended, Pharma Funds NAV
    UTI Sector-Pharma 9.7 1.7% -1.8% -32.0% -17.6%
    Magnum Sector Funds-Pharma 9.4 1.5% -2.7% -38.4% -5.5%
    K P Pharma (Gr) 9.3 -2.8% -5.5% -40.1% -0.6%

    Pharma stocks did not quite appreciate as anticipated after the days of the golden triangle. Consequently pharma funds have been downhill and have fallen by over 30% over the last 12 months.

    Open-ended, FMCG Funds NAV
    K P FMCG (Gr) 11.2 0.1% -5.3% -13.1% 9.3%
    Magnum Sector Funds-FMCG 8.0 -0.1% -7.3% -36.3% -14.8%
    Pru ICICI FMCG (Gr) 9.2 -0.4% -5.4% -24.3% -7.8%

    FMCG stocks haven’t performed much better than their pharma siblings, and this is reflected in the performance of FMCG funds.

    Essentially there was nothing wrong with pharma and FMCG stocks. To a question posed by personalfn.com on this issue, Rajat Jain (chief investment officer of IDBI-PRINCIPAL Mutual Fund) opined, ‘As far as FMCG is concerned, we are witnessing 6-7% volume growth. Add to this 6-7% inflation, and we have a 14% price growth, which is quite reasonable. These stocks have faced a perception problem vis-à-vis TMT stocks. The markets have tended to ignore these stocks in favour of the more aggressive TMT stocks, which have given over 100% returns in the past. I think investors must realise that it is not possible to get those kind of returns all the time, and FMCG stocks can also be rewarding.’

    ‘Like FMCG, the pharma industry is also good. And again it has been overshadowed by TMT just like FMCG. There seems to be nothing wrong with pharma companies as we have seen companies develop molecules and invest in research and development.’

    So after the euphoria with the golden triangle sectors died down, sectoral fund houses were left stranded caught by the restrictions of sectoral investments. Although fund houses would not readily admit it, investors can certainly not be blamed for feeling that sectoral funds are a big mistake. So were sectoral funds are little too ambitious? We asked this question to Mr Niamatullah (Managing Director – SBI Mutual Fund), to which he replied, ‘No, the decision to launch these funds was not ambitious. But given that they are sectoral funds, they are bound to fluctuate in line with the performance of the sector. This is the difference between a diversified growth fund and a sectoral fund. A sector has its ups and downs and the NAV reflects that. These sectors are pretty defensive compared to IT. So even if the upside is limited (when compared to IT), the downside is also limited.

    Pharma and FMCG sectoral fund investors cannot be faulted for regretting their investment decision. They may even be right in feeling cheated of growth on their investments. After all equities are meant to be more rewarding than bank and company fixed deposits. But we haven’t seen that happening over the last 12 months. Our study reveals that an investor would have been better off by investing in a bank, company or non-banking finance company fixed deposit (FD) as opposed to sectoral funds.

    Bank Interest Rate (%)
    Global Trust Bank 10.5
    Centurion Bank 10.0
    State Bank of Mauritius 9.8
    The Hong Kong & Shanghai Bank 9.8
    Bank of Bahrain & Kuwait 9.5
    Bank of Madura 9.5
    City Union Bank 9.5
    HDFC Bank 9.5
    IDBI Bank 9.5
    IndusInd Bank 9.5
    Karnataka Bank 9.5
    Lord Krishna Bank 9.5

    (The above table only shows the top 10 bank FDs)

    A query run on our fixed deposit database reveals that, bank FDs have given a return as high as 10.5% over 12 months.

    Company Interest Rate (%)
    Snowcem 15.0
    Nelco 13.5
    Premier Auto Electricals 13.0
    AEGIS 13.0
    Camp. & Allied* 13.0
    Herdillia Chemicals 12.5
    SRF Ltd. 12.5
    Dharamsi Morarji 12.0
    Greaves 12.0
    McDowell & Co 12.0

    (The above table only shows the top 10 company FDs)

    Company FDs have given returns as high as 15.0% over 12 months.

    NBFC Interest Rate (%)
    Ceat Finance 14.9
    Kinetic Lease & Fin 14.9
    Ceat Finance 14.0
    Kinetic Lease & Fin 14.0
    Kinetic Lease & Fin 14.0
    Nationwide Finance 13.8
    Inv Trust of India 13.7
    SREI Int Finance 13.5
    Nationwide Finance 13.1
    Weizmann Ltd 13.0
    Escorts Finance 13.0

    (The above table only shows the top 10 NBFC FDs)

    NBFC FDs have also given higher returns as compared to sectoral funds over 12 months as is evident from the above table.

    Seeing the dismal performance of sectoral funds, fund managers realised that what can work for you in a bull run in a particular sector, can work against you when that sector is hit by the blues. So how did funds counter this? One innovative way adopted by funds was by making necessary ‘adjustments’ in the investment objective of the fund by infusing a sense of flexibility, which does not bind a fund to a particular sector. So the Kothari Pioneer Internet Opportunities Fund was launched with the explicit investment objective of investing in companies that will benefit from the Internet. This includes just about any company – related to technology or otherwise. So while the Fund has invested in Infosys, Satyam Computers and Hughes Software (as on September 30, 2000) that are all about technology, it has also invested in Hindustan Lever, HDFC, M&M and Cadbury where technology is not the focus, but since the Internet is expected to play some role in the future of these companies, they qualify for investments.

    Other funds limited exposure to a group of sectors rather than one sector in particular. For instance, the PruICICI Technology Fund was launched targeting the "technology intensive" sectors, covering hardware, software, Internet, telecom, media, life sciences. Ditto for the DSP ML Technology.com Fund. On the same lines, the DSP ML Opportunity Fund can invest in the lifestyle sector, pharma, cyclicals and technology. Other funds like the Tata Life Sciences Fund have also introduced a little flexibility in their investment objective so as not to tie the fund manager’s hands.

    Some other funds adopted a rather unusual investment strategy for their sectoral products. For instance, the Unit Trust of India (UTI) bought NIIT, Satyam, Infosys and Zee Tele under its Growth Sector Fund – Petro as on June 30, 2000. Equally inexplicable was UTI’s Growth Sector Fund – Pharma’s exposure to Reliance of all stocks. Both these funds had ventured beyond the sectoral limitations they had defined in the investment objective, thereby sending the wrong signals to thousands of investors. The fact that the Securities and Exchange Board of India (SEBI) has been anything but a watchdog in this regard certainly hasn’t helped.

    So what is the future of FMCG and pharma sectoral funds? What is the recourse for investors who had taken to these funds in anticipation of exciting growth opportunities? Investors who had invested in FMCG and pharma funds in the golden triangle (software, FMCG, pharma) heydays clearly have some thinking to do. Obviously the ‘exciting growth’ in these sectors seems to have dried up, although there are some who feel we haven’t seen the last of pharma as yet. Either way, there is little investors can expect in the short term. While pharma is knowledge-driven and has a lot of potential, FMCG is unlikely to give exciting returns, even in future. To this extent investors in FMCG funds are better off investing in a diversified growth fund, as opposed to sticking with a staid FMCG fund.



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