Sectoral Mutual Funds, also known as Sector Funds, are a type of Equity Mutual Fund that focuses its investments on a specific sector or industry within the economy. Unlike Diversified Equity Funds, which spread investments across various sectors, Sectoral Funds employ a more concentrated approach.
These funds are suited for investors who are ready to accept higher risks in exchange for the potential of higher returns in a volatile market. In this article, we'll explore what sectoral mutual funds are, how they operate, and their benefits.
Mutual funds are a well-liked investment choice for many individuals. They provide a diversified portfolio of stocks and bonds, which helps to reduce risk. Sectoral mutual funds are a type of mutual fund that has gained popularity in recent years. In this article, we will discuss what sectoral mutual funds are, how they work, and their advantages.
What are sectoral mutual funds?
Sectoral mutual funds are equity-oriented funds that invest in companies within a specific industry or sector. These funds focus on businesses aligned with a particular sector, providing investors with targeted exposure to a chosen segment of the economy. This specialised approach allows investors to benefit from the growth potential of industries poised for medium- to long-term expansion.
India's economy encompasses various sectors, such as technology, banking, pharmaceuticals, natural resources, and more. Each sector performs differently depending on market conditions, economic policies, and industry-specific trends. For example, the technology sector might flourish due to innovation, while banking may thrive in a growing economy. By investing in sectoral mutual funds, you can strategically allocate your resources to industries expected to outperform, thereby optimising your returns.
Sectoral funds are particularly suited for investors with a deep understanding of specific industries or those willing to take calculated risks. While the potential for higher returns exists, it’s crucial to remember that these funds are inherently riskier than diversified funds due to their concentrated focus. Therefore, a thorough analysis of the sector’s growth prospects, economic relevance, and market dynamics is essential before investing in these funds. Sectoral mutual funds offer an opportunity to align investments with your market insights and growth expectations.
How do sectoral funds work?
Every equity mutual fund invests the money collected from investors in stocks of companies. The only difference with a sectoral fund is that it invests all its money in stocks of companies that belong to the same sector. A sector is defined as a group of similar businesses that provide the same category of products or services.
For instance, the technology sector consists of companies that provide technology-related products or services. Similarly, a pharma sectoral fund will invest in companies that provide pharmaceutical-related products or services. As an example of how diverse sectoral funds can be, it is not necessary that the pharma sectoral fund will invest in companies that only manufacture medicine. It has a host of other options that it can invest in like hospitals, diagnostics, etc.
Furthermore, sectoral funds invest in companies of all sizes from large-cap to mid-cap to small-cap; but the only mandate is that they should belong to the same sector. As per the norms set by SEBI (Securities and Exchange Board of India), all fund managers who take care of sectoral funds need to invest at least 80% of the fund’s total assets in equity and equity-related instruments of a particular sector.
Features of sectoral mutual funds
Sectoral mutual funds focus on investing in companies within a specific industry or sector, such as technology, pharmaceuticals, or banking. These funds aim to capitalise on growth opportunities within a particular sector, offering investors concentrated exposure to industries expected to outperform. Sectoral funds are equity-oriented and are best suited for investors with high-risk tolerance and thorough sector knowledge. These funds provide the potential for significant returns, especially when the chosen sector thrives in the market. However, their concentrated investment approach also increases risk, as performance is directly tied to sector-specific trends and market conditions.
Additionally, sectoral funds are actively managed, with fund managers leveraging their expertise to select high-performing stocks. They are ideal for long-term investments, as sector growth often takes time to materialise. These funds are subject to market risks and require careful evaluation of sector performance, industry regulations, and macroeconomic trends before investing.
Types of sectoral mutual funds in India
Listed below are the types of sector mutual funds available for investing in India:
- Technology Funds: These mutual funds concentrate on electronics and IT companies, offering investors exposure to the dynamic technology sector.
- Financial Funds: Enabling investment in financial industry stocks, this category covers banks, insurance companies, investment firms, and accounting entities, providing a broad spectrum within the financial domain.
- Natural Resources Funds: Focused on energy, forestry, oil, natural gas, and timber-related industries, these funds suit investors seeking long-term growth opportunities in resource-based sectors.
- Precious Metal Funds: Catering to those interested in precious metals like gold, silver, platinum, and palladium, these funds offer a channel for capitalising on the potential gains in the precious metals market.
- Real Estate: Providing an avenue for small investors to engage in real estate, these funds offer income and growth benefits within the real estate market.
- Communication Funds: Primarily investing in the telecommunication sector and other internet-related companies, these funds align with the ever-evolving communication industry.
- Utility Funds: Geared towards providing steady dividends, utility funds invest in companies within the utility sector, offering stability and income.
- Healthcare Funds: Investing in pharmaceutical companies, for-profit healthcare institutions, lab chains, and biotechnology firms, these funds also support companies involved in groundbreaking research within the healthcare industry.
- FMCG Funds: Sector funds in the fast-moving consumer goods (FMCG) industry, investing in companies producing essential everyday items, reflecting stability and consistent demand.
Advantages of sectoral mutual funds
Here are some advantages of investing in sectoral mutual funds:
- Potentially high returns: Sectoral funds provide several benefits to investors. First, and most importantly, they may have the potential to earn you high returns. However, for that to happen, the sector you choose to invest in needs to perform well.
The nature of sectors is cyclical; hence, any sector you choose will have good cycles and bad ones. Research and analyse your desired sectors carefully, and observe them over a period of time, so that you invest in the correct cycle to have a chance of making exponential returns.
To give you an example of this, people who chose to invest in pharma sectoral funds earned returns of over 27% when the outset of Covid happened.
Thus, if you choose the right sector and the right timing, you could earn better returns than normal.
- Targeted exposure: By investing your money in a specific sector, you get increasingly exposed to the market performance of that industry. If you have sufficient knowledge or expertise to judge the performance of this sector fairly over time, you may benefit from knowing just when to buy stocks, and when to sell.
- Diversification: If you want to have a diverse portfolio, but do not wish to spread your investments out over multiple industries, sectoral mutual funds are a great option for you. They help diversify your investments within a particular industry or market segment. This way, even if one or two companies in your portfolio do not earn high returns, the others will likely perform well and thus mitigate any loss.
Who should invest in sectoral funds?
- Aggressive Investors: Sector funds, being among the riskiest mutual funds, suit individuals comfortable with embracing high levels of risk in their investment portfolios. These funds cater specifically to venturesome investors seeking potentially high returns.
- Informed Investors: Delving into sector funds necessitates a nuanced understanding of market trends and effective timing for entry and exit. Even seasoned investors may find this challenging. Staying abreast of sector-related news and conducting thorough research is crucial for making informed investment decisions in this domain.
- Tactically Oriented Investors: Investors equipped with substantial knowledge about a particular sector, coupled with a robust risk appetite, can strategically capitalise on the cyclical nature of sector funds. Strategic entry during a sector's downturn and timely exit during its upswing can be advantageous for investors with tactical allocation preferences.
How should you invest in a sector mutual fund?
Sector funds are ideal for investors who are prepared to assume higher risks to potentially benefit from a volatile market. Investing in sector mutual funds can be straightforward and convenient through several methods, including:
- Asset Management Company
- Online platforms, such as the Bajaj Finserv Platform
- Branches of the issuing company
Taxation of Sector-based Funds
Investors venturing into the realm of the best sectoral mutual funds should be well-versed in the associated tax considerations.
Long-Term Capital Gains (LTCG): For investors holding units in a sector fund for a period exceeding one year, they accrue long-term capital gains. The first Rs. 1 lakh of such gains remains tax-free within a financial year. Any returns surpassing this threshold incur a 10% tax, without the benefit of indexation.
Short-Term Capital Gains: Contrarily, if an investor holds units for less than one year, the resulting gains are categorized as short-term capital gains. A 15% tax rate is levied on such gains, emphasizing the importance of considering the holding duration for tax optimisation.
Risks involved while investing in sectoral mutual funds
- Cyclical sensitivity
Sectoral mutual funds are inherently tied to the cyclical nature of their respective industries. The performance of these funds often fluctuates with the economic phases affecting the sector, such as growth, stagnation, or decline. For example, a fund focused on the infrastructure sector may perform well during periods of high government spending but could face challenges during economic slowdowns or reduced capital investments. This reliance on cyclical trends makes these funds highly susceptible to market volatility. - Limited diversification
Unlike diversified mutual funds, sectoral funds concentrate their investments in a specific industry or sector, such as technology, banking, or healthcare. This singular focus provides targeted exposure but also limits the risk-spreading benefits of diversification across multiple sectors. Consequently, any adverse developments within the chosen industry, such as regulatory changes, declining demand, or supply chain disruptions, can significantly impact the fund’s performance. - Amplified risk and reward
The lack of diversification magnifies both potential gains and losses. While strong sector growth can yield impressive returns, an underperforming industry can result in substantial losses. For instance, a banking sector fund could deliver robust returns in a flourishing economy but may struggle during periods of high non-performing assets or financial instability.\ - High dependency on market timing
- Successful investment in sectoral funds often requires precise timing and a deep understanding of sector dynamics, making them more suitable for experienced or informed investors.
Investment strategy of sector mutual fund
The investment strategy of sectoral mutual funds revolves around targeting specific sectors poised for growth. Fund managers actively identify and invest in high-potential companies within the chosen sector, aiming to maximise returns. The strategy is based on analysing sector performance, market trends, and economic indicators to forecast growth opportunities. Sectoral funds focus on a concentrated portfolio, which can amplify returns when the sector performs well but also increases risk if the sector underperforms. Investors need to have a high-risk appetite and a long-term investment horizon to navigate the inherent volatility of these funds successfully.
Factors to consider before investing in sector funds
When contemplating investments in sectoral funds, it is crucial to evaluate several factors for informed decision-making.
- Align with Investment Goals: Before delving into sector funds, align your investment objectives with long-term financial goals, such as education funding or building a retirement corpus. A recommended investment horizon of 5 to 10 years is advisable to navigate the potential risks associated with these equity funds.
- Gauge Risk Appetite: Sectoral funds represent concentrated investments, necessitating a high-risk appetite from investors. Be prepared for the elevated risk inherent in these mutual fund schemes.
- Diversify Your Portfolio: To mitigate risks associated with sector funds, it is prudent to maintain a diversified portfolio with other mutual funds. Limiting exposure to sectoral funds is advisable due to their inherently high risk.
- Understand the Expenses: Consider the expense ratio charged by Asset Management Companies (AMCs) to cover administrative and operating costs. Sector funds often entail higher sales charges and annual expenses, making it imperative to assess the expense ratio's impact on overall returns.
Conclusion
In conclusion, Investors seeking high-risk opportunities may choose sectoral funds. These funds concentrate on a specific sector, and their limited diversification makes them among the riskiest mutual funds. Therefore, only the investors comfortable with high-risk scenarios should contemplate investing in them.
Hence, make sure to thoroughly research the industry before putting your money into any specific sectoral fund. Begin securing a prosperous future by investing in mutual funds on Bajaj Finserv.
