UNIVERSITY OF MUMBAI

A PROJECT REPORT ON ON SECTORAL FUNDS OUTPERFORMED DIVERSIFIED FUNDS

Submitted by:

Hitesh Jain

Under the guidance of: Prof. Viraj Sadekar

MASTERS OF MANAGEMENT STUDIES

VIVEKANAND EDUCATION SOCIETYS INSTITUTE OF MANAGEMENT STUDIES AND RESEARCH BATCH: 2008 2010

DECLARATION
I, Hitesh Jain, student MMS (Finance) of Vivekanand Education Societys Institute of Management Studies & Research, Chembur, Mumbai, hereby declare that, I have completed a research project on Sectoral Funds outperformed Equity Diversified Funds during the academic year 2009-10. The information submitted is true and original to the best of my knowledge.

Hitesh Jain M.M.S (Finance) Academic Year 2008-10

ACKNOWLEDGEMENT
I take this opportunity to express my deep gratitude and thankfulness for those who have given their invaluable time, support and cooperation in the project work, without their advice and help; I could not have accomplished the task.

In preparing this progress report I have been fortunate to receive valuable assistance, suggestions and support from numerous teachers of VESIMSR, who taught over the past two years, and friends who have been able critics of my action and work. I am deeply indebted to my project guide, Prof. Viraj Sadekar, for giving valuable advices and help, both technical and other, throughout the duration of the development of this project.

INDEX

Sr. No. 1 3 4 5 6 7 9 10 11.

Contents Executive Summary Introduction Literature Review Objective Research Design Data Analysis Limitations of the Study Conclusion References

Page No. 5 6 10 14 15 17 19 20 21

Executive Summary
The purpose behind this research is to examine the superiority between Diversified Equity Funds and Sectoral Funds. 5 funds which are active in the market from past 7 years from the respective investment category would be selected for the purpose of the study. In Pharma Sector, only 3 funds are selected as only 3 funds are currently active in the market in the 7 year category. The period of study taken was 2004-2010. The data was taken from valuereserachonline.com. The Performance analysis was done on the basis of Sharpe ratio as well as on the average returns of past 7 years. As per the analysis Equity Diversified Funds has outperformed Technology Sector. However nothing can be concluded in the Equity Diversified Fund v/s Pharma Sector category. It is also been found out that since the total risk of the portfolio its standard deviation is used in the Sharpe ratio, diversification does not play any role in performance analysis. The Sharpe ratio is useful measure for an investor, which puts all his money in one fund.

Introduction
The Purpose of this study is to understand what type of mutual fund is most preferred by the existing customer because performance of these funds is the criteria for customer selection and which Fund has outperformed between Sectoral and Equity Diversified Funds. There has been a longstanding discussion of which fund between sectoral and diversified fund gives better returns. On the one hand theres a Equity Diversified fund who has a very good long term record in delivering great returns with low to average risk. The risk involved in this type of fund is moderately low. On the other hand theres a Sectoral Equity Fund, which invests in only a particular sector. Of late, a lot of investors are showing keen interest in sectoral funds. Sectoral funds are high risk/ return funds and cannot form a base for your portfolio. When a sector is performing well, these funds tend to outperform the diversified funds. It may not be the case in the long run.( especially in cases like a sector taking a sudden downturn).

Sectoral Equity Funds

There are funds that invest in a specified sector of economy and they specialize in the said sector. However, they run the risk of not being able to diversify. Sector based funds are aggressive growth funds which make investments on the basis of assessed bright future for a particular sector. The specialty of sector funds rather oddly lies in the fact that they go against the very grain of mutual fund investing i.e. holding a diversified portfolio. That is why you will find some Asset Management Companies that swear against sector funds! Sector funds are launched with the intention of capitalizing on opportunities in a single sector, for example the pharmaceutical industry, the software industry among others. The fund invests in various stocks from the same industry thereby making it a high risk-high return investment proposition.

Diversified Equity Funds

Typically, a diversified equity fund invests in a number of equity/ equity related instruments from various sectors thereby enabling investors to benefit from diversification. Equity Diversified fund has a very good long term record in delivering great returns with low to average risk. The risk involved in this type of fund is moderately low. HDFC Equity Fund and Sundaram Growth Fund can be classified as conventional diversified equity funds.

Mutual Fund Industry in India:The Indian mutual fund industry's average assets under management (AAUM) grew for the third month in succession and stood at Rs. 5.02 trillion in February 2009 as compared to Rs. 4.62 trillion in January 2009. The AAUM crossed the Rs. 5 trillion milestone in February 2009 for the first time after it dipped below this level in October 2008. Indexing has flourished because it is compatible with both theoretical findings and practical needs. On the theoretical side, the philosophy of passive fund management emanates from the efficient market hypothesis. If the markets are difficult to beat, then there is no point in spending money to devise methods and strategies to outperform the market. Instead of the high return high cost approach it is better to focus on market return low cost approach. This kind of differentiated product has an appeal to treasury managers and high networth individuals and has resulted in huge inflows from institutions, corporations and high networth individuals. These investors are in a position to demand and expect pre-defined performance from the investment managers. They not only look at the overall performance but also investigate the factors that contribute to the overall performance. The fund management company has to respond to this situation. Therefore, it is of paramount significance that we find a method to attribute the overall index fund performance to causal factors of relevance. In the last ten years (November 1998 to November 2008), the Indian market has grown by an average 12 per cent annually, the boom years and the earlier sluggish period all told. During the same period, fund managers have generated a return of 18-20 per cent for diversified equity funds, a good proxy for the broad market. But thats just half the story. Things have been changing over the last five years. Beating the market isnt a cakewalk these days. And the outperformance of a fund relative to its benchmark - also known as alpha - has been falling gradually. Overall, fund managers have given a return of 15.33 per cent over the last five years while the markets returned 13.5 per cent. Here, if we add a 2 per cent dividend redistribution that an index fund investor can benefit from, then the returns from the market will be 15.5 per cent on par with any active fund manager.

But then averages can sometimes be misleading - especially since a clutch of fund houses and their star fund managers have done far better than the average.

Literature Review
Performance evaluation of mutual funds is one of the preferred areas of research where a good amount of study has been carried out. The area of research provides diverse views of the same.

Richard Kjetsaa, Journal of the Academy of Business and Economics Study ( 2005 ) says that The rationale underlying investing in sector funds is the observation that exceptional investment performance often occurs with specialized or focused portfolios. In fact, sector funds regularly appear at the top of the list of best-performing funds--but the lack of diverse industry holdings also induces some sector funds to populate the bottom of the relative annual performance scale. Sector funds can play a role in a diversified portfolio; however, a portfolio exclusively constructed with sector funds would be highly volatile with erratic performance, and high expenses, portfolio turnover and manager turnover.

Marcin Kacperczyk, (2004 )Study has investigated using U.S. mutual fund data from 1984 to 1999, we find that mutual funds differ substantially in their industry concentration, and that concentrated funds tend to follow distinct investment styles. In particular, managers of more concentrated funds overweigh growth and small stocks, whereas managers of more diversified funds hold portfolios that closely resemble the total market portfolio. We find that funds with concentrated portfolios perform better than funds with diversified portfolios. This finding is robust to various risk-adjusted performance measures, including the four-factor model of Carhart (1997), the conditional factor model of Ferson and Schadt (1996), and the holding-based performance measures of Daniel, Grinblatt, Titman, and Wermers (1997). Analyzing the buy and sell decisions of mutual funds, we find evidence that the trades of concentrated portfolios add more value than the trades of diversified portfolios.

In summary, this paper finds that investment ability is more evident among managers who hold portfolios concentrated in a few industries. The evidence lends support to the value of active fund management.

In the Indian context, Amanulla (2001) tested the portfolio efficiency of mutual funds of Unit Trust of India (UTI) by employing traditional performance measures such as Jensen, Treynor and Sharpe's methodology. Employing Granger Causality and Co-integration tests, the paper also investigated the performance evaluation of mutual funds. Average weekly net asset values of 16 mutual funds of UTI and two stock market price indices i.e. Bombay Stock Exchange (BSE) sensitive index as well as S & P CNX Nifty index for the period June, 1992 to July, 2000 were used in the study. The results from traditional measures provided a mixed evidence of performance evaluation while the evidence from Granger causality suggested the existence of uni-directional causality in BSE sensitive index and bi-directional causality in Nifty index. The market index and mutual funds were also found to be co-integrated, indicating a long-run relationship.

Brands, Brown and Gallagher [2005] conducted a study of active Australian equity managers and found a positive relationship between portfolio concentration and fund performance at the stock, industry and sector levels. They defined portfolio concentration as the extent to which the portfolio weights held in stocks, industries and sectors deviate from the underlying index or market portfolio.

Ivkovich, Sialm and Weisbenner [2006] found that stock investments made by households that choose to concentrate their brokerage accounts in a few stocks outperform those made by households with more diversified accounts (especially among those with large portfolios). They found that when controlling for households average investment abilities, their trades and holdings perform better when their portfolios include fewer stocks. Ivkovich et al. use the term concentrated to refer to investors who hold only one or two stocks in their brokerage accounts,

and use the term diversified to refer to investors who are not as highly focused with their portfolio (i.e., hold three or more stocks). AlphaProfit.coms research suggests that By allocating assets across a group of sector funds, investors can effectively create a diversified mutual fund portfolio using sector funds. This approach gives the investor flexibility to over-weight or under-weight certain sectors versus broadly diversified indexes such as the S&P 500. To implement this active approach to money management, it helps to have a diverse group of sector funds to choose from. Fidelity Investments manages 41 sector funds under the Fidelity Select Portfolios umbrella which makes this family of sector funds well-suited for this purpose. By dividing assets across, say, 8 sector funds in the Fidelity Select Portfolios, e.g., Fidelity Select Biotechnology (NDQ: FBIOX), Fidelity Select Computers (NDQ: FDCPX), Fidelity Select Energy Service (NDQ: FSESX), Fidelity Select Home Finance (NDQ: FSVLX), Fidelity Select Medical Delivery (NDQ: FSHCX), Fidelity Select Multimedia (NDQ: FBMPX), Fidelity Select Retailing (NDQ: FSRPX), and Fidelity Select Wireless (NDQ: FWRLX), one can build a customized diversified portfolio. With each of the sector fund managers actively scouting for the best investment ideas within their sectors, this cluster of Fidelity Select Portfolios packs a lot of power into your diversified portfolio.

Wachter, Jessica A. and Wurgler, Jeffrey A. (2007), studied trading skills of the fund manager associated with the ability to buy stocks that are about to enjoy high returns upon their upcoming quarterly earnings announcement and to sell stocks that are about to suffer low returns around the next earnings announcement. The results yield new evidence of trading skill by mutual fund managers. The future earnings announcement returns on stocks that funds buy are, on average, higher than the future returns on stocks that they sell. The stocks that funds buy perform significantly better at future earnings announcements than stocks with similar characteristics, while the stocks that funds sell perform significantly worse than such stocks. Fund trades predict not just earnings announcement returns but EPS surprises as well.

Cohen, Randolph B., Coval, Joshua D. and Pastor, Lubos, (2003) had developed a performance evaluation approach in which a fund manager's skill is judged by the extent to which his investment decisions resemble the decisions of managers with distinguished performance records. They proposed new performance measures that exploit the information contained in the similarity of a manager's holdings (or changes in holdings) to those of managers who have performed well, and in their distinctiveness from those of managers who have performed poorly. These performance measures use historical returns and holdings of many funds to evaluate the performance of a single fund. As a result, these measures are typically more precise than the traditional return-based measures. Shukla and Singh ( 1994 ) tested proposition whether portfolio managers advance professional education resulted in superior performance, and found that euity mutual funds managed by professionally qualified managers were riskier but better diversified than the others. It also pointed that these fund managers outperformed others as a group, although performance difference was not considered statistically significant. Grubber ( 1996 ) attempted to resolve the puzzle relating to fast growth of mutual funds inspite of inferior performance of actively managed portfolios. The study reported that average mutual fund had negative performance compared to the market and provided evidence to support the persistence of performance. It resolved the puzzle that sophisticated clientele withdrew money from mutual funds in the event of poor performance, whereas these mutual funds found money from disadvantaged clientele under such circumstances. Gupta and Sehgal ( 1998 ) evaluated investment performance of 80 mutual funds schemes for the Indian market over a four year period 1992-1996. It tested propositions relating to fund diversification, consistency of performance, parameter of performance and objective stationarity in addition to examining risk return relationship in general. The empirical results reported in the study indicated that mutual fund industry has performed reasonably well for the Indian market. It noticed lack of adequate portfolio diversification. The study produced evidence to support consistency of performance and its non-stationarity over-time was noted in relation to risk-return parameters. Finally , a significant and positive risk-return relationship was documented by the study when standard deviation was used as a risk measure.

Objective
Objective:The present study has been undertaken with the object of examining, analyzing and inferring the performance of the mutual funds, which addresses the following issues:

To understand what type of mutual fund is most preferred by the existing customer because performance of these funds is the criteria for customer selection. Which mutual fund is the best in its category? Which Fund has outperformed between Sectoral and Equity Diversified Funds.

Hypothesis:Ho = Equity Diversified Funds outperforms Sectoral Funds. H1 = Sectoral Funds outperforms Equity Diversified Funds.

Research Design A. Methodology

The empirical technique used here is the Sharpes Ratio. Sharpes measure also known as return to variability ratio, is used to evaluate investment performance of managed portfolio by excess returns in terms of variability of the realized returns. The excess return is the differential return of ex-post portfolio return and the riskless return. The ratio may be positive or negative. This measure is often used to investigate the investment performance of managed portfolios as well as to rank the portfolios in terms of performance. Sharpes ratio = (Ex post or realized return on portfolio Risk free rate of return)/ Standard Deviation (variability or risk ) of the portfolio return.

Rp Rf -----------

Interpretation of Sharpes Ratio

The Sharpe ratio indicates the excess return per unit of risk associated with the excess return. The Sharpe ratio does not refer to the market portfolio or any other benchmark. Actually, the implicit benchmark is the risk free rate of return Its higher value indicates superior portfolio performance, while the lower value implies inadequate investment performance.

B. Data and sample description

This study groups the funds into 2 investment categories: Diversified Funds Sectoral Funds Pharma Sector Technology Sector 5 funds which are active in the market from past 7 years from the respective investment category would be selected for the purpose of the study. In Pharma Sector, only 3 funds are selected as only 3 funds are currently active in the market in the 7 year category. The period of study would be from 2004-2010. The data would be taken from valuereserachonline.com.

Details of the sample Investment categories Diversified Equity Funds

Pharma Birla Sun Life Mid Cap Plan A Reliance Growth Hdfc Top 200 DSPBR Equity Templeton India Growth Franklin Pharma UTI Pharma & Healthcare Magnum Pharma

Sector Equity Funds

Technology DSPBR Technology.com Reg Franklin Infotech ICICI Prudential Technology Birla Sun Life New Millennium Magnum IT

Data Analysis
Summary descriptive statistics for investment categories across 5 mutual funds in each category. Equity Diversified Funds V/S Pharma Sector
Fund Name Birla Sun Life Mid Cap Plan A Reliance Growth Hdfc Top 200 DSPBR Equity Templeton India Growth 3 year Return 21.63 20.3 22.06 20.65 23.03 5 year Return 26.22 28.95 27.68 28.3 24.7 7 year Return 39.81 47.7 40.56 41.72 36.88 Fund Name2 Franklin Pharma UTI Pharma & Healthcare Magnum Pharma 3 year Return 23.66 16.45 3.59 5 year Return 21.12 14.11 10.29 7 year Return 30.09 23.87 27.73

Equity Diversified Funds V/S Technology Sector

Fund Name Birla Sun Life Mid Cap Plan A Reliance Growth 3 year Return 5 year Return 7 year Return Fund Name2 DSPBR Technology.com Reg Franklin Infotech ICICI Prudential Technology Birla Sun Life New Millennium Magnum IT 3 year Return 5 year Return 7 year Return

21.63 20.3

26.22 28.95

39.81 47.7

8.11 1.73

23.36 14.96

33.15 23.61

Hdfc Top 200 DSPBR Equity Templeton India Growth

22.06

27.68

40.56

-0.67

15.92

26.82

20.65 23.03

28.3 24.7

41.72 36.88

-1.44 -5.13

14.62 16.24

26.4 23.73

Sharpes ratio
Investment categories Diversified Equity Funds
Sharpes Ratio Birla Sun Life Mid Cap Plan A Reliance Growth Hdfc Top 200 DSPBR Equity Templeton India Growth 0.46 Pharma Franklin Pharma UTI Pharma & Healthcare Magnum Pharma

Sector Equity Funds

Sharpes Technology ratio 0.66 DSPBR Technology.com Reg Franklin Infotech 0.46 0.10 ICICI Prudential Technology -0.04 Sharpes ratio 0.24 0.06

0.46 0.54 0.39 0.53

Birla Sun Life New Millennium -0.06 Magnum IT -0.12

Interpretation of Sharpes ratio

Sharpes measure also known as return to variability ratio, is used to evaluate investment performance of managed portfolio by excess returns in terms of variability of the realized returns. The excess return is the differential return of ex-post portfolio return and the riskless return. As can be seen from the above calculations, sharpes ratio has been the highest for the Franklin Pharma Sector Fund and has been negative for the Technology Sector Fund.

Limitations of the Study

Data has been analyzed for only 7 years January 2004- December 2009 which may not be sufficient for arriving at a conclusion.

There may be a difference of opinion regarding the appropriateness of the statistical tools used for analysis. This study also does not take into account fluctuations in the fund returns due to change in the state of the economy like recession, inflation etc. Due to lack of availability of data in Sectoral Funds, data is limited to Pharma and Technology Sector.

Conclusion
This papers primary contribution is in providing more conclusive evidence on the debate Whether the Sectoral funds has outperformed Diversified Equity Funds. It is found that, Equity Diversified has got better returns than technology sector in each of the 3 year, 5 year and 7 year category. The Sharpe ratio of the equity diversified funds was also better than the technology sector. However, nothing can be concluded in pharma sector category as there is no correlation between the returns and the sharpe ratio. It is also been found out that since the total risk of the portfolio its standard deviation is used in the Sharpe ratio, diversification does not play any role in performance analysis. The Sharpe ratio is useful measure for an investor, which puts all his money in one fund.

References
Cohen, Randolph B., Coval, Joshua D. and Pastor, Lubos, 2003, Judging Fund Managers by the Company They Keep, Journal of Finance, American Finance Association, vol. 60(3), pp 1057-1096 Gruber, M.J., 1996, Another Puzzle: The Growth in Actively Managed Mutual Journal of Finance, vol51, pp.783-810. Richard Kjetsaa( 2005 ), The performance of sector mutual funds relative to benchmarks, Journal of the Academy of Business and Economics Study Marcin Kacperczyk, (2004 ), On the Industry Concentration of Actively Managed Equity Mutual Funds, Social Science Research Network Gajendra Sidana, Debashis Acharya( 2007 ), Classifying mutual funds in India: some results from clustering, Indian Journal of Economics and Business David Blanchett (2009 ), Portfolio Concentration And Mutual Fund Performance, Index Universe. Sam Subramanian, Using Sector Funds to Construct Diversified Mutual Fund Portfolios, Buzzle.com. Baker, Malcolm P., Litov, Lubomir P., Wachter, Jessica A. and Wurgler, Jeffrey A., 2007, Can Mutual Fund Managers Pick Stocks? Evidence from Their Trades Prior to Earnings Announcements Ramesh Chander, Performance Appraisal of Mutual Funds in india www.valueresearchonline.com Funds,