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Sectoral funds are riskier than simple diversified funds

A fund that invests infrastructure companies would an be example of a sectoral fund

What is the difference between a sectoral and a thematic fund?

—Vijaya Reddy

In the world of domestic equity mutual funds (MFs), there are simple diversified funds and schemes with specific mandates. In the case of the former, the fund manager might be constrained by a particular segment of the market, or not be constrained at all. In the case of funds with specific mandates, they are always constrained in one form or the other. When this constraint requires a fund manager to focus on a specific sector in the market, such funds are called sectoral funds. All other constrained equity funds are broadly classified as thematic funds.

A fund that invests either in banking stocks or infrastructure companies would an be example of a sectoral fund. These cannot veer away from their particular sector when choosing their investments (though fund managers occasionally stretch the definition of a sector when they see opportunities outside). Funds that make Shariah-compliant investments, or those that invest in companies focused on rural Indian would be some examples of thematic funds. Both these categories place constraints on a fund manager as to where investments can be made, and for that reason, they are riskier than a simple diversified fund.

I have about 5 lakh in savings. Will equity MFs double my investments in the next 5 years?

—Deepak Shetty

To double an investment in five years, a portfolio would need to generate a compounded annual growth rate (CAGR) of about 15%. We looked at historical returns data of equity funds to see what are the chances for such returns over the next five years. Over the past 15 years, the average diversified equity MF has returned 20.3% over an average five-year period. One should also note that there have been some very bad five-year periods as well. The worst five-year period for the average equity fund gave a negative return of 3.7% (conversely, the best five-year period gave a big 57% CAGR). There were 10 equity funds that did not suffer a single five-year period of negative return over the past 15 years (including some regulars in Mint50, our selection of the best funds). Over the past five years, diversified equity funds have returned upwards of 17% CAGR.

Past performance can tell us that there is a reasonably good chance of getting the returns you are expecting, but there are no guarantees.

If you absolutely need the money at the end of five years and are not willing to take risks, you should allocate 20–30% to debt funds or invest the whole amount in balanced funds for this period.

If you are flexible with the time period and can take some risk, you can go with an all equity funds portfolio by choosing funds from the Mint50.

Queries and views at mintmoney@livemint.com

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