Mutual funds are one of the topmost investment options for the majority of investors today. There is an array of options that can be used by investors to invest in mutual funds based on the asset classes as well as the risk-return profile of the investor. Some of the common types of mutual funds often preferred by investors are equity mutual funds, debt funds, or hybrid funds. Another common type of mutual fund often ignored by many investors is sectoral funds or sector-specific mutual funds. However, for an average investor, information about sector funds may be sparse which may be a hindrance for investors targeting such funds.
Given below are the meaning and a few related details of sectoral funds.
What are sector funds?
Sector mutual funds are sector-specific funds that allocate a majority of their investments in a particular sector or industry. As per SEBI guidelines, sector funds need to have a minimum investment of 80% in their target sector. Investors that target stocks in a specific sector can invest in sectoral funds to gain the maximum advantage of the returns from this sector.
The key to earning good returns in sectoral funds is the timing of investment as the businesses in these funds are usually cyclical in nature. Therefore the entry and exit in the market by the investors pose a direct impact on the ability to earn good returns. These mutual funds also have the inherent benefit of diversification, however, it does not significantly reduce the risk of investment. These funds are concentrated in a particular sector and hence, any unfortunate market trend or cycle can affect the fund in a negative manner and drain the overall returns for the investors.
Target investors
These funds are generally not suitable for risk-averse investors. The cyclical nature of the funds makes it riskier for investors with a lower risk profile. Also, investors who typically have a longer investment profile can invest in these funds. The short-term volatility will not allow the investors to gain more returns as compared to long-term investment in sectoral funds.
The ideal holding period for sectoral funds is between 5 years to 7 years. So investors having a similar investment horizon can invest in these funds. Furthermore, since sector funds target specific sectors, it is important for the investors to have good knowledge about such sectors and their market fluctuations. In any case, most experts suggest that the maximum percentage of the investment in sectoral funds should not exceed more than 5% to 15% of the total portfolio. Some of the common types of sectoral funds include
| Sector | Target investments |
| Real estate | These funds invest in real estate companies and REITs |
| Healthcare | These funds invest in stocks of pharma companies, biomedical companies, medical supplies manufacturers, hospitals conglomerates, etc. |
| Finance | These funds target investments in banks, mutual funds, companies in the life insurance sector, etc. |
| FMCG | These funds target consumer goods that are non-cyclical in nature and are never out of demand |
| Energy | The energy sector invests in companies related to the production and distribution of energy in various forms. |
| Natural resources | These funds target companies that are in the business of extraction and usage of natural resources like minerals, metals, oil, gas, energy, etc. |
What are the features of sector funds?
Some of the key features of sector funds are highlighted below.
- High-risk high return funds
The key feature of these funds is their high risk-high return profile. When the market trend favours a particular sector, investment in such funds becomes quite profitable. At the same time, when the market fluctuations are against a particular sector, the sectoral fund aiming at such a sector suffers huge losses. Hence, investors have to be cautious of their investment in such funds.
- Targeted funds
These funds target a particular sector and invest a minimum of 80% of their funds in such sectors as pharma, banks, energy, real estate, etc. Therefore, the diversification is limited to the extent of different stocks in the same sector. Also, the performance of the fund is directly proportional to the performance of the sector as a whole.
- Investment horizon
The investment horizon of sectoral funds is usually medium to long term i.e. anywhere between 5 years to 7 years. Therefore, these funds are not ideal for investors who are aiming to make short-term gains. These funds need a long duration to generate sufficient returns and investors should ideally exit the market when the cycle of the sector reaches its peak. This will help them generate maximum returns on their investment.
- As an hedging instrument
Hedging is an excellent way to minimize the risk of the overall portfolio. Therefore, investing in sectors that are generally inversely proportional to the economy as a whole is a good way to hedge the overall investments and ensure that the losses at the time of a slump in the economy are manageable.
What are the factors to consider while investing in sector mutual funds?
After discussing the various details of the sector funds, let us now consider the key factors to be considered while investing in them.
- Past performance of the fund
The first and foremost factor to be considered is the past performance of the fund. While it is true that investors should never base their investment decisions solely on the past performance of the fund, it is nevertheless important to review the same. If the fund is consistently making losses despite the sector not suffering too much, such a fund should definitely be ignored.
- The objective of the fund
SEBI mandates the minimum investment in sectoral funds to be 80%. Hence, it is important to check the objective of the fund to ensure that the fund has complied with this basic requirement. It is also prudent to check the other areas of investment as per the objective of the fund to determine the risk-return profile of the fund.
- The risk profile of the fund
The risk profile of the fund should be in line with that of the investor. These funds belong to the high-risk category as they invest the majority of their funds in a single sector. This makes them highly risky and returns are generated based on the cyclical nature of the sector.
- Thorough market research
As mentioned above, the returns of sectoral funds depend on their cyclical nature and the market trends. In order to understand this, the investors need to understand the business and the industry as a whole to ensure the various stages of the product cycle or the stages and indicators of ups and downs in the market. This will help them understand the better time to enter and exit the market to maximize their wealth.
- Ensure that these funds do not form a major part of the entire portfolio
A diversified portfolio is always a quality portfolio that can spread the risk as well as help in maximizing the wealth. Sectoral funds are a good addition to a portfolio however, investors have to ensure that the maximum investment in these funds does not make up a major chunk of their portfolio as it will increase the overall risk of the portfolio. The maximum investment in sectoral funds should be limited to up to 15% of the total portfolio.
Conclusion
Sector funds are thoroughly focused funds. Therefore, before investing in these funds, it is essential to have complete knowledge about them. Investing in these funds without thorough research can lead to losses as the investors may not be able to time the market and able to exit the funds to avoid losses. Investors should target sector funds that belong to a flourishing sector or sectors that have been consistently performing well to ensure maximum returns at minimal risks.
FAQs
The ideal holding period for sectoral funds is between medium to long term duration i.e., approximately 5 years to 7 years.
The ideal time period to invest in sectoral funds is when the cycle is about to begin or there is an upward trend in that particular sector based on some quality news like favourable changes in government policies, changes in the tax laws, or new innovations that can change the face of the industry, etc.
Sectoral funds are highly cyclical and volatile in nature. Hence, depending on merely sectoral funds to meet the long-term financial goals will be quite risky and not advisable.
Sectoral funds are taxed in line with the equity funds depending on their holding period. Short-term capital gains are taxed at 15% while long-term capital gains are taxed at 10% after an exemption of up to Rs. 1,00,000 in any financial year.
