Year 2007 is drawing to a close. But the party at Dalal Street is far from over. On Friday, the sensex closed at 20206.95, yielding a return of almost 45 per cent this calendar year. A gain of 44.93 per cent on top of 46.82 per cent in 2006 is something extraordinary for stock investors of any country.

If estimations of economic think tanks are anything to go by, 2008 will also be a reasonably good year for equity markets in India. Institutions such as IMF, S&P and the Asian Development Bank have forecast a GDP (gross domestic product) growth rate in the range of 8.5 per cent and 8.8 per cent despite a slowdown in developed countries led by the US.

Hot stocks

Therefore, in the coming years, more foreign funds will be chasing Indian stocks. “Given the growth forecasts, our conservative estimate is that the sensex will give an annual nominal return of 20 per cent for the next two years and 12 to 15 per cent till 2015. This means the sensex will cross 50000 by 2015,” said K.K. Mishra, a merchant banker.

But stock investments are considered risky by many. The net inflow into mutual funds in this calendar year was Rs 12,000 crore compared with Rs 33,500 crore in 2006. This was despite the fact that there were 48 new fund offerings in 2007 against 39 in 2006 in the equity and ELSS space where most retail investors put their money. Most of the inflows into mutual fund schemes this year came through existing schemes.

Wise investor

Retail investors are making informed decisions as they are putting in more money in equity and mutual funds. Reserve Bank data on household financial savings shows that in 2006-07, retail investors had put 6.5 per cent (or Rs 48,000 crore) of their Rs 7,58,751-crore financial assets in shares and mutual funds vis-à-vis 4.9 per cent (or Rs 29,000 crore) in 2005-06. It is provisionally estimated that household financial savings in shares and mutual funds in 2007-08 will reach the 1996-97 level of 7.5 per cent.

Household savings

Given the growth rate of household savings in financial assets at 18.3 per cent (in 2006-07), households are expected to hold close to Rs 70,000 crore in shares and mutual funds in this financial year and Rs 50,000 of this will be in mutual funds alone.

Hence it is all the more important to understand which mutual fund scheme one should invest in to get a good and steady return, especially when fund houses are coming up with all sorts of thematic schemes.

Wide choice

On the face of it, investors are bound to get confused by the wide variety of schemes. Should I buy a plain diversified equity scheme, a banking sector fund or an infrastructure fund, they ask. Gold exchange traded funds, index funds, contra funds, real estate funds, schemes that invest in overseas stocks — the list goes on.

A wider choice only increases the risk of default. One has to keep in mind that prudent investment is one that gives a good and, more importantly, a steady return.

Thematic funds

There are wide dispersions in thematic funds’ returns. Given the performance of the economic sector the scheme has based its theme on and the selection of stocks by the fund manager, a thematic fund can top the return chart or sink to the bottom.

The fund manager in a thematic or sectoral fund is restricted by the fact that even if the sector is not doing well, the manager cannot invest in companies in any other sector. And every sector goes through its own business cycle.

For example, while infrastructure and banking sector funds are in vogue today, technology and auto sector funds are not. In 2001-2002, when auto and pharmaceutical industries were doing well, a number of mutual fund houses came up with auto and pharma funds. As these industrial sectors are not doing well today, these schemes have sunk to the bottom of the return table. It’s a similar case with the technology sector.

Free hand

But look at average returns of plain diversified equity and tax saving plans of mutual funds. Here, fund managers are free to choose any company across sectors and market capitalisation without any bias of theme. If the infrastructure sector is doing well, the fund manager can easily replace the underperforming stocks in the portfolio with a good infrastructure company.

This explains why diversified and equity-linked saving schemes give a steady return over time and outperform broader market returns.