Sector Mutual Funds

sector mutual funds

The majority of individuals diversify their portfolios by investing in mutual funds in a variety of methods. Investments in various asset types, such as equities, debt, real estate, gold, etc., are one way to diversify your portfolio. Investing in diverse economic sectors is another way of investment diversification. You can invest in a particular economic sector or sector through a variety of mutual funds. Here you will find some crucial details you should be aware of regarding sector mutual funds.

What is a Sector Mutual Fund?

Sector Mutual Funds are equity schemes that invest solely in businesses that operate in a specific industry or sector of the economy. Sector funds are commonly structured as mutual funds or exchange-traded funds (ETFs). For example, Real Estate Funds, Utility Funds, Natural Resources Funds, Technology Funds, Financial Funds, Communication Funds, etc.

Sector Funds are also referred to as sectoral funds and can invest in stocks of companies with varying market capitalizations as well as security types in the best-performing stocks in the specified sector. As per SEBI mandate, the fund managers of sectoral funds have to invest 80% of the fund in equity and equity-related instruments of a specific sector.

Why should you invest in Sector Mutual Funds?

The Sector Funds offer a great option to invest and diversify in a specific sector(s). The risk of investing directly in the specific stocks is minimized as a Sector Fund gives exposure to an entire sector that is going to experience growth. For example, an IT sector fund invests only in IT companies, Sectoral-Technology Funds have on average delivered 19.03% p.a. returns in the last 5 years. Their 3- and 10-year annualized returns are 33.75% and 20.23% p.a.

So, if the demand for a certain product rises, then all companies belonging to that sector can experience growth. A sector fund will give you good returns by investing in well-performing companies from that sector.

But, on the other side, since the fund invests primarily in one sector, a downturn can lead to heavy losses.

Factors to consider before investing in Sector Mutual Funds

As an investor always look at the past performance of the fund before investing. You can consider the following parameters before investing in Sector Funds.

Investment Goals: Be clear on your investment goals. To make the most out of your investment in sectoral funds have an investment horizon of at least 5 years. Because it takes a significant amount of time for any sector to reach its pinnacle. Therefore, you should have long-term goals like retirement planning, child’s education planning, etc. while investing in these funds.

Investment Risks: Sector funds don’t offer diversification in your portfolio which also means higher risk in your portfolio. Sector funds are confined to one sector and hence, cannot take advantage of other performing sectors. So, for any economic reason, if the entire sector is not performing, your investment portfolio also underperforms. Therefore, the sector funds have the potential to give exceptional returns, but so are the risks.

Portfolio Exposure: Don’t put all your eggs in one basket, since the risk is extremely high in the case of sectoral funds, it is important to have a strong and balanced portfolio and limit your sector exposure to 5-10% of your portfolio. Always have a diversified portfolio of regular funds before investing in sector funds.

Expense Ratio: You should be aware of the fund’s administrative and operating expenses that impact your returns. Asset Management Companies charge you to manage the sectoral fund a fee called an expense ratio. It is charged on an annual basis.

Learn about the sector: An in-depth understanding of the sector and identifying investment opportunities in the sector will help you cash in on an opportunity in a particular sector. The sector funds usually perform in a cyclic manner and therefore the investor should have a good understanding of how the specific sector moves in the economy as well as of the factors that influence it.

Also, assess the past performance of sector funds to get an update on how the fund has performed and also to identify future opportunities in the given sector.

Taxation on Sectoral Funds: In an investment what matters are the post-tax returns. In calculating that, you should know how sectoral funds are taxed. The capital gains made on selling your sector fund are taxed depending on the duration of the investment held by you.

Short-Term Capital Gain Tax (STCG): If you sell your investments within 1 year, the gains are classified as Short-Term Capital Gain Tax (STCG). 

Long-Term Capital Gain Tax (LTCG): Any sectoral fund held for more than one year, the gains are classified as taxed Term Capital Gain (LTCG).

Key Takeaways:

  • Sector funds invest in one identified industry or sector.
  • Sector funds are usually available as mutual funds or exchange-traded funds (ETFs).
  • Sector funds can be more volatile because they focus on only one area of the economy, hence no diversification.
Location: India

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