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S. Vaidya Nathan

A STUDY of stock price patterns over the last five years emphasises the need for a diversified portfolio. Sector-specific investing — the focus of sector funds — can be extremely risky.

The returns are also not commensurate with the risk. This is especially true of sector funds with a focus on information technology stocks.

The volatility level of IT-sector stocks is thrice that of the average market portfolio. The returns in a few IT-focussed funds such as Pioneer Infotech looked attractive till the meltdown started in early 2000.

Since then such funds have struggled to cope with declining prices. This has meant unattractive returns.

This trend is unlikely to change. The problems may, in fact, get worse. The universe of investible IT stocks has shrunk with quite a few second- and most third-rung stocks doing badly with little scope of recovery. But IT stocks still account for 60-70 per cent of the trading volumes.

This is essentially because of runaway day trading. Their high volatility levels make these stocks attractive for day traders. But this hectic trading activity has not done much to improve the position of the genuine investor. In fact, day trading and volatility reinforce each other and this has not worked to the benefit of investors. In such sectors as consumer goods (FMCG) and pharmaceuticals, the risk levels are lower or in line with that of the broad market.

But, here too, the performance of one subset of stocks has counter-balanced the non-performance of the other. For instance, in the five-year period under review, stock prices of pharma MNCs have been on a steady decline.

This has run counter to the sharp run-up in valuation of domestic pharma companies such as Dr Reddy's Labs, Ranbaxy Labs, Sun Pharma, Wockhardt and Cipla. Pharma-specific funds have had a reasonable balance between MNC and Indian stocks and, as a result, returns have been more or less non-existent. This is despite the BSE Healthcare Index posting a return of about 24 per cent. The heavier weightage for Dr Reddy's, Ranbaxy and Cipla explains the divergence.

The shrinking universe of MNC stocks has also not helped the cause of FMCG funds in particular.

A look at the performance of sector-specific funds shows that those with a wide investment brief, say, UTI Services Fund, Tata Life Sciences & Technology Fund, Alliance Basic Industries (after an indifferent start), have done well.

These funds basically have diversified portfolios and this has helped them do better than funds with single sector focus.

If returns are going to get lumped in one or two quarters in a four-year period (ignoring 1999 when there was an across-the-board bull run), sector funds will have difficulty in even sustaining what they gain in such periods.

Barring Birla IT Fund in 2001, none of the funds has shown an inclination to maintain large cash positions if there is no opportunity in stocks in the sector. In any case, holding cash for long is also not in the interest of investors.

By shuffling between stocks within the sector, the funds have necessarily transferred gains made from a set of stocks to others and frittered away the gains.

The numbers — related to returns as well as risk — make a fairly strong case against sector funds in the Indian context. The lack of depth in the market and especially within each sector also add to the problems.

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