Investors have an option to invest in different segments of the markets through a variety of funds following different philosophies and strategies. If chosen well, these funds allow investors to earn better than market returns over time.
Therefore, the key is to have the right mix of funds in the portfolio. Ideally, you should begin with diversified funds as these funds invest in a wide range of stocks across various industries and hence provide stability to the portfolio. Once you have built a reasonably large equity funds portfolio and learned the nuances of equity investing, you may consider taking the next step of investing in exotic funds. However, the decision whether to include or not to include these funds in the portfolio, as well as the extent of exposure would depend mainly on your risk profile.
While most of the investors are familiar with plain vanilla equity funds, the mystique surrounding exotic funds often compels them to either invest aggressively in these funds or shun them altogether. A better understanding of these funds can go a long way in getting the best from them. Here is what they offer:
Contra funds :
A contra fund is actually a contrarian fund that bets on unrecognised value of out-of-favour companies. The reasoning behind this approach is the belief that, sooner or later, other investors will realize the true value of these companies and buy their shares, thereby increasing the stock prices. These funds are ideally suited for investors looking for an option that has the potential to perform in different market environments by blending both growth and value opportunities together.
Sector funds :
Sector funds are highly focused in that their investments are aimed at a particular sector/industry. The basic idea is to enable investors to take advantage of the industry cycles. Since these funds ride on market cycles, they have the potential to offer good returns if the timing is perfect. However, sector funds should constitute only a limited portion of a portfolio as they are much riskier than a diversified fund. As these funds invest in one industry or sector, they do not provide the downside risk protection available in a diversified fund.
Thematic funds :
Thematic funds focus on structural as well as cyclical factors that play an important role in the economy. These are more diversified than the sector funds as they look for trends that are likely to result in outperformance of certain sectors or companies. Besides, by incorporating macro environment in the investment process, a thematic fund adds value and protects investments from adverse movement in macro environment. On the negative side, the market may take more time to recognize views of the fund house with regard to a particular theme that forms the basis of launching a fund, and hence, there could be long periods of poor/underperformance.
Mid-cap funds :
Mid-cap funds invest in mid-cap stocks, as their name suggests - short for middle or medium sized capitalisation. Earlier, MFs used to have their own definition of mid-cap stocks. However, SEBI has now defined mid-cap stocks as the ones that are ranked from 101 to 250 in terms of market cap. Mid-cap funds are a good means to enhance returns and add a flavour of growth to the portfolio. Investors with some appetite for risk should consider adding mid-cap funds to their existing mutual fund portfolio. 'Existing' is the operative word over here. It means that investors must have a portfolio to begin with, preferably with either large-cap or large-cap oriented multi-cap funds forming a substantial chunk.
Value funds :
A value fund essentially invests in stocks that are deemed to be undervalued in price. Simply put, a fund manager following value investing tries to take advantage of the market inefficiencies that allows him to buy stocks at less than their intrinsic value. Even though there is a case for an established investor to include some of these funds in his portfolio, it will be prudent to have a limited exposure to begin with. Your “bread and butter” funds in the portfolio should always be diversified funds.