Making The Right Investment Choices

If an investor understands a particular sector well, can devote time for in-depth study, has a considerable long-term investment horizon and wants to earn higher returns, sectoral investing can be a right choice, recommend Dr. Ruzbeh Bodhanwala and Dr. Shernaz Bodhanwala, faculty at FLAME University, Pune 

Investors who are either beginners or those who do not have very sound knowledge of stock-picking and also do not have the time to track their investments should stick to index investing. Our finding suggests that index investing generates a decent return with least amount of risk over a long-term period. Investors can either look at index funds that mimic the broader indices like BSE Sensex or Nifty 50 or can also look at sectoral index funds. During different economic cycles, some sectors are seen to perform better as compared to others.

For example, during a period of economic growth, generally sectors like financials, consumer durables, automobiles, etc. tend to do well. On the other hand, during a period of crisis, say for example the current pandemic situation, sectors like pharmaceutical, FMCG and healthcare did relatively well. This argument makes us think whether investors can generate higher returns taking sectoral bets as compared to investments in a broader index fund? A broader index portfolio consists of many sectors and it is possible that there are a few sectors which have been generating higher returns as compared to other sectors and thus can create more wealth for the investor.

So, in this study, we have analysed the past performance of a few sectors and index investing. We calculated the risk and return from investing in these sectors so that investors can make an informed decision. For the analysis, we obtained monthly closing index values from March 29, 2006 to March 29, 2021 and calculated yearly returns. We also calculated the mean, median and the standard deviation to capture the risk. Table 1 provides the data for the returns YoY as well as the average, median and standard deviation and also a 15-year compounded annual growth rate.

As indicated in the table, the average return of S & P BSE Consumer Durables’ price index was the maximum at 26 per cent, closely followed by S & P BSE Bankex’ price index at 20 per cent. Since the average values are influenced by extremely high and low values, it is good to look at the median values. Considering the median returns, S & P BSE Bankex price index and S & P BSE Fast Moving Consumer Goods’ price index generated returns in excess of 19 per cent and very comfortably beat all the three benchmarks i.e. S & P BSE Sensex 30 Sensitive price index, MCI Gold Rs 99.5 per 10 grams and a much broader index S & P BSE National 500 price index.

Now let’s look at the risk levels. S & P BSE Sensex 30 Sensitive price index has a standard deviation of 0.28 and if we use this as our benchmark, the risk levels of concentrated risk in one sector are higher across all sectors except S & P BSE Fast Moving Consumer Goods. Investing in gold has the minimum level of risk across the table but let’s remember that investing in gold, which is considered to be a safe haven, also is risky. Investors should know about their own risk tolerance level before making investments in sectors with higher level of risk.

This phenomenon highlights the point that higher the risk, higher the returns. Investors seeking higher returns have to expose themselves to higher levels of risk. So if an investor understands a particular sector well, can devote time for in-depth study, has a considerable long-term investment horizon and wants to earn higher returns, sectoral investing can be a right choice. However, limiting one’s exposure is the key as laying all eggs in a basket can prove to be fatal. Investors should properly diversify themselves to limit excessive risk exposure. For more details on companies within each sector you can visit the URL
https://www.bseindia.com/sensex/indexhighlight.html

Dr. Ruzbeh Bodhanwala and Dr. Shernaz Bodhanwala, faculty at FLAME University, Pune