Sectoral Mutual Funds

A sectoral fund is an equity fund that invests the money of investors in businesses belonging to the same industry or sector. These funds let investors take exposure in specific sectors of the economy by putting all their money in companies of the same sector.

As of late, SEBI's recategorization has modified the foundation to determine whether an organization is Large Cap, small-cap, or mid-cap. Large Cap organizations are those that constitute the top 100 companies in terms of market capitalization.

The Indian economy consists of different sectors such as technology, banking, pharma, natural resources, and more. Some of these sectors might perform outstandingly well in the medium to long term. Sectoral funds are an avenue that is built with the aim to help investors capitalize on such opportunities.

Every equity mutual fund invests money mobilized from the investors in stocks of companies. The only difference with a sectoral fund is that it invests its entire money in stocks of companies that are in the same sector.

A sector, basically, consists of similar businesses that provide, more or less, the same type of product or services. For instance, take the Technology Sector. It consists of companies like Infosys, Wipro, Tech Mahindra, Microsoft, etc. So a sectoral fund that is aimed towards investing in the Technology Sector will have a portfolio of businesses belonging to the technology sector. Similarly, a Pharma Sectoral Fund will invest in companies like Cipla, Biocon, and GlaxoSmithKline Pharma. Here, 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.

Further, 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. Also, according to SEBI, all fund managers of sectoral funds need to invest 80% of the fund's total assets in equity and equity-related instruments of a particular sector.

• High Returns if Sector you Choose Performs:

  All sectors don't move in tandem with the economy. Sectors are cyclical in nature. They have some good ones as well as some bad ones. So, based on your research and analysis, if you can catch the right cycle, you have a chance of earning exceptional returns by investing in sectoral funds. For instance, many investors earned exceptional returns of over 27% on their investment in Pharma Sectoral Funds during the outset of the Covid disease. Thus, only if the sector you believe in hits the spot, your portfolio returns are going to be good, probably it could be higher than a well-diversified fund too.

• Investors willing to take High Risk:

  As mentioned above, these funds invest in a specific sector and this lack of diversification means these are one of the riskiest mutual funds available. So only those investors who are comfortable with taking high risk should consider investing in them.

• Well-Informed and Active Investors:

  If you're a first-time investor, you should not jump into sector funds right away. Investment in sector funds needs timing one's entry and exit right, which is something that even experienced investors struggle with. It needs rigorous research about the sector. Active investors who are constantly abreast of the news and headlines can take a better call on whether which sector is going to perform well. Even investors who are closely related to the sector (by work), will have access to insights that can help them make the most out of their investment in sectoral funds.

• Investors Looking to Make Tactical Allocation:

  There are some sectors that are considered to be cyclical sectors like the auto sector. So, investors who can have a high-risk appetite of taking exposure in businesses that are at the bottom of their cycle can make a great deal by investing in sectoral funds. A shrewd investor can invest in a sector which is at the bottom of their cycle, and patiently wait till the time it reaches its peak. Once it reaches its peak, they can immediately sell it to book profits. Thus, it requires a knack and some amount of patience to invest in sectoral funds.

• Investment Goals:

  Before investing in these funds, one should be clear about their investment goals., if you want to make the most out of your investment in sectoral funds, then you should have an investment horizon of at least 5 years. The reason is simple. For any sector to reach its peak, it takes a significant amount of time. Thus, you should have long-term goals like retirement, funding a child's education, etc. while investing in these funds.

• Investment Risks:

  Sectoral funds are concentrated investment, which means they don't offer diversification in your portfolio. The lesser the diversification, the higher the risk in your portfolio. Unlike other equity funds that invest in companies across different sectors, Sectoral funds are just restricted within the confines of one sector and cannot take the advantage of other sectors simultaneously. So, for some reason, if the whole sector is struggling, there is no other investment in the portfolio that can protect you in such times. Thus, even if the return potential seems to be exceptional, the risks are equally high.

• Exposure Limit:

  Since the risk is extremely high in the case of sectoral funds, you shouldn't be giving too much weightage to it in your portfolio. You should limit your exposure in sectoral funds to a maximum of 5-10% of your portfolio.

• Expense Ratio:

  You should be cut-clear about the expenses that bite into your returns. In order to manage the sectoral fund you're planning to invest in, the Asset Management Companies charges you a fee called an expense ratio. This is basically the charge to cover the fund's administrative and operating expenses like the fund manager's salary. It is charged on an annual basis.

• Short Term Capital Gain Tax (STCG):

  If you sell your investments within 1 year, the gains are classified as Short Term Capital Gain (STCG) and you need to pay 15% tax on them.

• Long Term Capital Gain Tax (LTCG):

  Whereas, any sectoral fund held for more than one year, the gains are classified as taxed Term Capital Gain (LTCG). Gains of up to 1 lakh in a financial year are tax-free. Beyond 1 lakh, the gains are taxed at a rate of 10%.

Let's look at some of the top-performing mutual funds helming the sectoral fund category. The performance is based on the basis of returns provided by the fund in the last 3 and 5 years.