Monday, Jun 27, 2022

Playing Sector Rotation In Equity Investments

Stock prices are a function of the performance of the company and perceived future growth. Depending on these factors prices tend to go up and down and it these oscillations which provide an opportunity for wealth creation.

Playing Sector Rotation In Equity Investments
Sanjay Relekar, Proprietor, Pragati Associates

Equity markets consists of various sectors. Businesses in each of these sectors have their own cycles of growth, stagnation and recession at different stages in their individual life. Over a period of time a pattern emerges for each of these sectors and these patterns tend to repeat with varying degrees of similarity and periods. In financial parlance, there patterns are known as cycles. The trigger points for these cycles could vary from sector to sector. If you an individual with an ability to read these cycles, then you can very well capitalize this knowledge in stock markets.

Stock prices are a function of the performance of the company and perceived future growth. Depending on these factors prices tend to go up and down and it these oscillations which provide an opportunity for wealth creation. Generally, investors believe that the market moves up and down but in reality the various sectors which make up the markets is what moves up and down. 

Practical Challenges 
For a trained eye every sector provides some cues about the probable future trajectory of a sector and consequently the stock price of the companies operating in that sector. So, one of the keys to consistent wealth creation can be identifying such sectors/names just before the boom and exiting sectors/names before growth plateaus leading to price correction or stagnation. However, this is no easy task. Recognizing cycles requires expertise, discipline and market experience which can provide invaluable insights. None of these is available with a lay investor.

Another challenge an investor faces is that once a winning stock starts showing warning signs, it is very difficult to sell/exit them as they could have been multi-baggers or generated significant gains for the investor. As a means to justify their actions, often the maxim of long term investments is used which is nothing but an excuse when following this strategy. After all, as a lay investor, no one has the wealth to keep on holding all the stocks they ever invested into. What is necessary in this strategy is to rotate sectors as per the changing dynamics among the various sectors as extrapolation of past profits is not a good investment method. This will help in avoiding loss of past profits and generate better future prospects from emerging opportunities. Moreover, wealth creation in equity investments is always forward looking.

The third factor which could prove challenging is reallocating money in a tax efficient manner. Allocating money across various sectors by buying and selling at opportune times comes with some level of complexity given the taxation element. Also, one need to correlate these sectors with the changes occurring in the economy at any point in time. So, transitioning from one sector to the other fruitfully itself is a tedious exercise. Furthering this point, the next challenge comes in terms of allocating weightages to various sectors while constructing a portfolio. Assigning weightages have to be a well thought out exercise as it sometimes could be a make or break factor for the portfolio.  

Finally, the last hurdle comes in the form of timely execution. While one may have all the necessary knowledge and data, what ultimately helps is timely execution of transaction be it on buy or sell side. Dilly dallying sometimes can prove to be a costly mistake as turnaround stories in some case tend to transpire in the form of runaway stock prices. 

Each of the challenge here is a daunting one for an investor who is not clued into the markets and the developments occurring in the economy. So, the easiest alternative is to entrust a fund manager to do it for you. It is here that ICICI Prudential Thematic Advantage Fund comes into play. The fund very succinctly surmounts each of these challenges for its investors. If one were to consider the fund performance, it is evident that the fund has managed to rotate sectors efficiently and has even surpassed the performance of the individual constituents of the fund. Another added advantage is that when the rotation occurs, individual investor not worry about the tax incidence. The fund also has the flexibility to take a limited exposure to international securities as and when the opportunity arises. In effect, through a single fund, investors can pocket gains from sector rotation.