Diversification is a must. Diversification across asset classes (equities, debt, fixed income instruments, etc) and various time horizons ensures that your risks are well spread.

The impact of events like a sharp downswing in the markets can be minimised by a diversified portfolio.

The developments over the last few days have once again highlighted the needs for a diversified portfolio of assets.

Within the gamut of equity funds, sector specific funds have enjoyed a reasonable degree of popularity, especially in the rising market that we witnessed till recently.

In the recent past sectors like pharma, banking and basic industries have all witnessed rallies and sector funds which invest in these stocks had hit a purple patch as well.

Are sector funds bad per se? Not really. For an informed investor who has a view on the sector and can time his entry and exit, sector funds can prove to be very profitable propositions.

However, if you are a lay investor who is relying on the fund manager to deliver, diversified equity funds is the place to be. The mandate for a conventional equity fund is generally much broader and it permits the fund manager to invest across sectors; i.e. the fund manager has far more flexibility at his disposal.

Sadly for a sector fund manager, this option is sorely missing. There is virtually no exit option, at best he could hold a higher proposition of his holding in cash. Moving into a different sector would amount to a breach of the mandate and would be unfair to the investors.

A cursory glance at the top 10 holdings in some of the sector funds reveals a lot about their investment style. For example as on April 30, 2004, JM Basic Fund had 68.9% of its corpus invested in its top 10 stocks, similarly the figure for UTI Sector Fund -- Petroleum was 78.2%.

The comparative figures for diversified equity funds paint a fairly different picture, as on April 30, 2004 Sundaram Growth Fund held just 39.8% of its net assets in the top 10 holdings; the number was 35% for HSBC Equity Fund. Thanks to their concentrated holdings, sector funds are prone to take an especially harsh beating in a bear phase.

This is clear from the performance of sector funds in the last one week.

Conversely, diversified equity funds have managed to put up a far better showing in the same market conditions; their well-spread holdings provided them with the much-needed cushion.

Times like these can be real eye openers for investors; take a serious look at your risk appetite and your ability to read the markets. Do you have an informed view on a given sector, can you afford to take a huge hit on your investments (capital erosion to the extent of 1/5th in a single month as seen in some sector funds)?

If yes, then a sector fund is the place to be, else stick to diversified equity funds. They are your best bet at beating the markets.

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