A reader recently sent in this query: Should I continue my SIP in Nippon India Pharma fund? Will pharma stocks continue to perform well?
It was with great interest that I read it because I completely identified with the quandary he found himself in.
I too invested in a healthcare fund when the sector was pretty much in the doldrums. Unfortunately, when the sector did rally, I was not sure when to sell. I could have exited at a very tidy profit, but I hesitated. It was then that I realized that investing in a sector fund is probably the investing equivalent to a superfecta bet in horse/greyhound racing.
Why do I say this?
A superfecta bet is when you place a bet on the first four to finish the race, in the correct order. That’s a tall order, betting on which one will win the race, and which one will finish second, third and fourth.
When it comes to a sector fund, you must get four things right too:
- Pick a winning theme.
- Pick a fund that is well-placed to harness that theme.
- Pick the time to enter.
- Pick the time to exit.
Such funds can shoot out the lights one year and be a loser the next because they essentially lack the diversification to ride out trouble. Unlike a regular equity diversified fund, the fund manager does not have much latitude if the sector falls from favour. So volatility is a given.
For instance, energy funds put up a stellar performance in 2007 with a category return of 105%. Investors piled onto them. The Global Financial Crisis (GFC) hit the next year and the category average was -53%. While it bounced back in 2009, its returns in 2010, 2011 and 2013 were abysmal. In 2014, it made a comeback with a return of 47%.
A more recent example is of PSU stocks. Nifty PSU delivered 44% in 2021, but this is after three consecutive years of negative returns,
This is why when investing in a sector fund, investors must act on a well thought out strategy. If they simply gravitate towards the flavour of the year, they are already behind. Individuals who invest in today’s winners are “buying backward”. They enter the fund at its peak, leaving little leeway for the investments to run. And then they have a horrible investing experience.
So, is it time to exit?
When investing in sector funds, always have an exit strategy in mind. What is your reason to offload? Do you have a return in mind? Then when you attain it, walk away. Don’t be upset about leaving potential gains on the table. You took a call and made money – don’t let greed mess it up.
Nifty Pharma delivered negative returns every year from 2016 to 2019. I entered early 2018 when it was languishing, but I did not catch the bottom. It fell further after I invested. I was perfectly fine with that because no one can accurately catch the peak or the trough. In 2020, it soared ahead with 61%. That was when I should have sold, but did not. The problem that I was so indecisive is because I had not put an exit strategy in place.
I wrote about this in more detail in My biggest investing goof-ups.
The market does not send out an invitation card informing you when to buy or sell. That is a call you have to make.
Now I will have to hold on till the next pharma rally. And there is no telling when that will happen. That is the closest I can get to answering his query.
This is important:
- One should never commit the grave error of investing in a thematic/sector fund simply because it has had a great run that year. Before you invest in a sector fund, you should be in a position to articulate your stance on why you believe that sector is likely to outperform, and what your criteria are for exiting it.
- If the sector rallies even a year after you invested and you made more than you thought you could, walk away. Don’t be afraid to leave potential gains on the table. Staying on in the hope that the sector will keep sizzling could backfire.
- If you play it well, sector funds will be able to deliver some stupendous returns on and off, giving your portfolio the muscle to outperform the market. Yet don’t lose sight of the fact that they can also log some dizzy falls. So do not let that disturb you or prevent you from sticking to your investment strategy.
- Research your fund. Not all thematic funds will effectively profit from the growth of their targeted trend. Yes, the portfolios are narrow, but all portfolios are not equal. Not in the stocks selected, the weightage to the top 5 stocks, or the number of stocks in the portfolio. Check the expense ratio too.
- Finally, when you invest in a sector fund, you should be geared to take a hit. After all, you may get your call wrong. Or, it may take years to make a profit. That is why they should corner a very small portion of your portfolio and must never be a core holding.
Articles authored by LARISSA FERNAND
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