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Sound stock strategy? Sector investing part and parcel of it

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Sector investing is an integral part of a well-diversified portfolio strategy.

Frequently, investors feel that if they get their equity exposure through a large cap fund based on the Sensex or the BSE 100 and then invest some amount in BSE MidCap Select, they are done with their diversification strategy. This is far from true.

The two sectors that make up any of these size-based indices each have their performance trajectory and a unique risk return profile.

For example, in India, the industrial sector has a low correlation to financials, information technology and even to the consumer goods sector. Similarly, healthcare and finance sectors have very low correlations. These kinds of correlations hold true globally since there is no reason to expect that the factors influencing the healthcare segment will impact the financial space in the same manner.

Demographics, economic growth rates, business activities, investor sentiment, and global economic currents can all influence various sectors differently. A savvy investor can bet on sectors differently based on the economic conditions that are expected to hold sway over the next few years.

Over the last 10 years, the BSE Sensex has grown at an annualised 9.3 per cent while an all cap index, which includes large, mid and small caps, has grown at a similar pace of 10.3 per cent.

During the same period, the BSE Fast Moving Consumer Goods index grew 18.2 per cent, reflective of India's burgeoning middle class and its younger demography.

Meanwhile, the BSE Telecommunication dropped 3.5 per cent, reflecting the bitter competition among providers, falling telecom charges and the impact it has had on telecom stocks. Information Technology has done better, with the index growing 15.1 per cent during this time period.

If we look at the short term, that is over the last one year, performance differential can be even starker. Healthcare has actually fallen 13.5 per cent while consumer goods, IT and materials have all shown high double-digit growth.

Sector performance is subject to both local and global factors. For example, global trends around commodity prices impact commodity or material stock prices similarly. Sometimes, local demographic trends can be more powerful.

A well-rounded investment strategy should take into account sectoral impact and performance and endeavour to diversify the equity exposure by targeting low correlated sector investments.

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