Investing in Sectoral Funds? Try core and satellite approach

 “We've been raised to compete, to want more! More! More! It's a way of life. It's about greed”.

Sandy Duncan

The above quote by Sandy Duncan matches the psyche of the investors. In today’s current austere markets, fund delivering a 1-year return of above 20% is unimaginable. But there are some funds that have managed to leap over that bar. Returns from Pharma and FMCG funds headed northwards at a time when the returns from most of the funds from the diversified equity space are struggling.

Lured by the handsome returns from the sector funds, one often invests huge sum of money in to these funds. Investor falls to the prey of greed of making quick short term money forgetting the basic of long term investing. While some of the investors earn super fat returns, some are not lucky enough to get the desired return.
When a sector booms, one can easily get carried and invest more into the sectoral funds. Such a move can surely impact the portfolio if the sector goes kaput. So the basic question is should one invest in sector funds?

Sector Funds

Sector funds have a risk element present in them as the investment is concentrated only in few and particular specific sectors. Whereas for diversified equity funds, the investments are spread across a number of sectors, which largely reduces the risks.

Sectoral funds start to hog the limelight when the particular sector starts to perform well. Investors, greedily invests into them thinking them to be the best possible way to earn some quick money by jumping on board.

There can be times when a sudden gush of positive news will help the particular sector to outperform from the others. Furthermore, some conditions can be created or emerged by the government or the economy, which can lead to a strong growth for the companies associated in the sector. These could be the possible investment entry points for the sectoral funds.

Conversely, a situation may arise where a certain group may not perform in a particular sector. For example, in Infrastructure sector, real estate may grow or may not grow. Even if they perform well it would not be possible to say which ones will perform well from the others. 

Another key parameter to keep in mind is portfolio composition. Certain mutual funds have more weightage to certain specific companies, which translates that the performance of these funds will be solely dictated by the performance of these companies. If these companies perform well, the returns will automatically get inflated and vice-versa. More weightage into a particular sector will actually warp the risk.

Segregate your Investments

A better investment approach would be core-satellite way of investing. The core portfolio seeks to preserve the wealth over the long term, where as the satellite portfolio helps the value of the portfolio to appreciate or rather to multiply the returns. In mutual funds, core portfolio generally consists of investments made into diversified equity space and in debt mutual funds, which has the potential to generate returns in future. Separately, the satellite portfolio consists of some sectoral funds like energy, infrastructure, Pharma, FMCG and etc which are more risky in nature, with a view that they might outperform the market in the near term.

How Does It Work?

The core portfolio is a long-term bet, so it is advisable never to compromise on the liquidity of investment instruments. The core portfolio strives for safety of capital, which means that the investors should strive to invest into the asset classes that offer better risk adjusted returns.

So, when it comes to investing into the equity mutual funds, the core portfolio will see investments in diversified equity funds with a long term track record with investments made in blue-chip companies.

When compared with core portfolios, satellite portfolio investing is still little known to the investors. Many of them find it difficult to get it right in most of the cases. Risk and costs are the two important parameters associated with satellite investments. Investors should have the ability to bear losses. Since the satellite investments are opportunistic trades, it’s vital from the point of view of investor’s to decide the profit-loss levels based on the investment tenure.

Power of two

A core portfolio approach ensures the investment goals remain on the right track through the way of long term investing into the diversified equity space and debt funds. The satellite portfolio approach ensures that the investor earns and adds some extra returns to their portfolio. In general, investing 10-20% of the total portfolio amount in the satellite holdings makes sense. Understanding the risks associated with satellite investing before getting into an opportunistic trade is highly recommended.

A little word of advice, before entering into the opportunistic trade, pre decide the entry and exit points, which will help to protect the capital. Separately, it’s not a wise choice to liquidate one’s core holdings to enter into an opportunistic trade.