I am 35 years old, married, with two children, and have been investing regularly in mutual funds. From many fund Web sites and articles, I find that sector funds focused on FMCG, pharma and banking have done better than diversified equity funds. SBI FMCG, ICICI Prudential Banking and Financial Services have given excellent returns. These returns are much better than large- or mid-cap funds.

On this basis, should I start SIPs in top sector funds? I am aware of the risks and uncertainties. If I invest through the SIP mode in these funds, which will help in cost averaging, will it not be better than investing in equity funds?

At present, I am investing Rs 2,000 each in Franklin India Bluechip, IDFC Premier Equity, ICICI Pru Discovery, Reliance Banking and Reliance Pharma schemes.

The sector funds have given me higher returns than the other equity funds.

I am willing to monitor the portfolio and can take more risks. I want to do SIPs for a period of 3-5 years in sector funds.

Equity funds such as Franklin India Bluechip have given good returns only over a 10-year period and not in 3-5 years’ time frame.

I am aware that the SIP method of investing is better than lump sum due to cost averaging.

Can I go ahead with the SIPs in sector funds? I am willing to make additional purchases in case the NAV crashes to average my cost and get more units.

Anand Krishna You seem to have taken a liking to sector and theme-based funds based on the great run that they have had over the past few years. Fast moving consumer goods (FMCG) and pharmaceuticals are two sectors that are generally considered to be defensives. Investors go heavy on those themes when the markets turn volatile as they tend not to fall or decline less when the going gets choppy.

This is not to say that these sectors do not have strong fundamentals. They certainly do.

These sectors have had a fantastic run, but valuations have turned expensive on an absolute basis and certainly much higher than the broader markets. In the absence of suitable alternatives, these defensives continue to do well.

But it is not a certainty that the performance will be repeated in the next few years. Banking is a more cyclical business and has its ebb and flow based on the economic situation as well as interest rates.

Theme or sector funds can fall in a heap if the underlying stocks underperform heavily. In 2004-07, infrastructure and power were fancy names, but the funds focused on these themes were decimated in 2008 and most of them are yet to recover.

So, as an investor you must keep these facts in mind. You have said that you can monitor these sectors, but it is an arduous task.

If you are insistent on FMCG, pharma and banking funds, you can invest small lump sums in it. You must, however, note that you must keep booking profits constantly in case of any abnormal gains and even exit these funds when target returns are achieved.

If you invest in regular diversified funds the scheme itself will invest in all the fancied and momentum sectors by taking active calls and manage the portfolio carefully. You may not get lumpy returns as seen in sector funds, but over a 10-year period, quality diversified equity funds will outperform benchmarks and also convincingly beat inflation.

This way your portfolio will not require constant monitoring other than, say, an annual appraisal to take corrective action.

Diversified equity funds must form the core of your portfolio. These funds will help you achieve your goals. Sector funds must form a small portion of your portfolio — these are just for generating excess returns as and when they come.

Coming to your portfolio, split the Rs 10,000 as follows — invest Rs 2,500 each in Franklin India Bluechip, IDFC Premier Equity, ICICI Pru Discovery and Quantum Long Term Equity.

As suggested earlier, invest in banking and pharma funds, by way of small lump sums when markets decline sharply, say, by 5-10 per cent and monitor them closely.

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