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Don't invest just because sector is in vogue

April 07, 2011 11:10 IST
If you are one of those who often get tempted to invest in funds that are in the limelight because of their short-term performance, this one's for you.

There are several pitfalls of following this strategy and it can ruin the long-term prospects of your investment portfolio.

Over the years, at different times, different categories of funds such as information technology, infrastructure, banking, midcap and, most recently, international funds have performed exceptionally well.

In fact, for a long time, new fund offerings were a craze among investors and, hence, many invested in every NFO that came their way.

No wonder, one often comes across investors who not only own a large number of funds, but also have a sizeable exposure to funds with a narrow focus.

What most investors forget is that these sectors - thematic and specialty funds - suffer from leadership shifts and changes in the business cycle from time to time.

This phenomenon explains the erratic performance of these funds. It is common to see these perform exceptionally well during certain periods, but perform inconsistently during other times.

Moreover, at times, the exceptional short-term performance of some of these funds may be a reflection of a segment's or a sector's performance, rather than the skill of the fund manager.

That's why investing in these funds require a different skill level and risk profile.

Broadly speaking, there are two kinds of investors - those who want to make quick bucks and those who seek long-term growth.

The problem occurs when some funds step into limelight due to their short-term performance and trigger the bandwagon effect, even on serious investors. It's times like these when greed takes over and everything
else takes a back seat.

Those investors who chase short-term performance are destined to fail, simply because more often, they end up investing at the peak.

Besides, they not only face the risk of portfolio drift, but expose themselves to more risk than their risk-taking capacity.

Although the importance of past performance in the investment process cannot be denied, it's critical to put performance in proper perspective.

While reviewing a fund's performance, one needs to not only look at the performance over different time periods rather than three-six months' performance, but the risk taken by the fund to deliver those returns.

There are a few other factors that drive investors to these funds. For example, many advisors are quick to capitalise on the short-term performance of funds by tempting gullible investors to invest in the "flavour of the month" type of funds.

Even some fund houses try to benefit from investing fads by quickly launching these funds. The media hype around these also makes it difficult for investors to resist the urge to rush into investing.

Remember, the key to long-term investment success is to resist the temptation of investing in 'flavour of the month' funds and stick with funds that suit one's risk profile and investment objectives.

It is equally important not to underestimate risks and/or overestimate rewards from an investment.

Simply put, estimating the risks associated with a fund are more crucial than estimating the returns. Investing, like many other things, involves risk in order to achieve returns.

By understanding investment risks and how they relate to potential returns, one can improve chances of building greater wealth.

Therefore, the key factor is to invest as an optimist and manage risk like a pessimist.

The writer is CEO, Wiseinvest Advisors
Hemant Rustagi in Mumbai