The mutual fund basket is getting bigger with the launch of exotic theme-based products — from international opportunities, infrastructure to natural resources.

But are these funds suitable for all?

Thematic funds generally deliver impressive returns when the underlying sector hits a purple patch. For instance, information technology funds were launched in 2000 when the sector was at its peak. Between 2000 and 2003, these funds reaped rich returns. However, as the technology boom fizzled out, the funds sank to the bottom of the return table. Over the last 12 months, they gave a negative return in excess of 20 per cent.

Banking sector funds, that were the flavour of the season till last year, yielded an average 33 per cent return in the last 12 months compared with a 22 per cent return by the sensex and 23 per cent by the Nifty. The best banking and financial services fund gave a 39 per cent return, while the worst-performing fund yielded 25 per cent.

Infrastructure funds have also given higher returns over the last 12 months than the bellwether share price indices and diversified equity schemes.

Sector or thematic funds deliver good returns over a short period, say one to three years. For a longer period of three years or more, diversified equity funds are clearly the winners.

Risk factor

The high risk involved in such funds is often ignored. In any mutual fund scheme, the total return has two aspects — one relates to the natural growth of the companies in the investment portfolio and the other is the stock selection and investment skill of the fund manager.

Manager’s call

In a sector-specific fund, the investment horizon for the fund manager is restricted by the industry or the theme set for the scheme. Hence, the fund manager’s skill in stock selection is an important consideration in such a scheme.

Cash chase

Another risk factor could be the large size of the investment corpus. If the sector or the theme chosen for investment has a small number of companies, the fund manager may face problems in deploying a large amount in the shares of those companies. First, stock prices skyrocket when a huge amount chases a fewer stocks. Second, a mutual fund scheme cannot hold more than 10 per cent of its entire investment portfolio in a particular company’s stock.

On demand

Let us look at the funds of Reliance Natural Resources and DSP Merrill Lynch Natural Resources. Launched in January this year, Reliance Natural Resources mobilised Rs 5,600 crore and DSP Merrill Lynch Natural Resources mopped up around Rs 2,500 crore in March.

At present, Sahara Mutual Fund is tapping the market with its Power & Natural Resources Fund. The NFO is on till May 27. Many others such as HSBC Mutual Fund, ING Mutual Fund and Tata Mutual Fund have filed their applications for natural resources funds with the market regulator.

Considering the returns collected by Reliance Mutual Fund’s new fund offers, it can be concluded that investor expectations are very high.

Mad rush

According to metal, oil and energy indices, companies in the natural resources sector have given a return of over 100 per cent in 2007 compared with around 50 per cent by sensex or Nifty.

The heightened interest among retail investors have encouraged mutual funds to venture into these sectors. But why is there a sudden rush for natural resources at a time when prices of base metals, crude oil, coal and other minerals have almost doubled during the last one year?

Prices of natural resources in the global markets have been rising despite a slowdown in the US and European countries. The demand for natural resources is fuelled by the fast pace of economic development in China, India, Brazil, Russia and other developing countries. Investors keen to benefit from this market trend turn to specialist funds to gain this exposure.

Both the governments and private firms are making huge investments in these sectors. Hence, any company which is associated with this sector is expected to grow at a robust rate.

However, mutual funds are not restricting themselves to natural resources. They are widening their reach by including sectors such as agriculture and energy.

“The risk associated with the natural resources sector is higher at 1.3 per cent, that means if the benchmark share price indices rise or fall by 1 per cent, the share prices of natural resources companies increase or decline by 1.3 per cent. On the other hand, the energy sector has a low risk between 0.94 per cent and 0.99 per cent,” said Naresh Garg, chief executive officer of Sahara Mutual Fund.

Reliance Mutual Fund proposes to invest a part of the corpus of its natural resources fund in overseas companies. HSBC Mutual Fund has included the agriculture sector in its proposed natural resources fund.

It is too early to predict how well these funds will perform. But most of the funds in these sectors, particularly energy and minerals, are overbooked for the next one to two years.

Informed decision

Sector-specific funds are best suited for informed investors. Retail investors can keep these funds to add variety to their portfolio comprising diversified equity and index funds.

It should be remembered that diversified equity funds also invest in natural resources companies. But since the investment portfolio of a diversified equity plan is spread across different industries, the risk is much lower than that of a sector-specific fund.