Just like a business performs with the co-existence of multiple departments like marketing, accounts, HR, etc. - the market performance is derived from the co-existence of various sectors like IT, financial services, fast-moving consumer goods (FMCG), etc. Equity mutual funds that invest at least 80% of total assets in equity & equity related instruments of a particular sector are known as sectoral funds.
What are Sectoral Funds?
Sectoral mutual funds are schemes that invest at least 80% of the portfolio in the companies that belong to a particular sector - like banking, real estate, pharmaceuticals, etc. These funds may diversify the portfolio across market caps. The purpose of these funds is to benefit from the (out)performance of a particular sector in the long run.
How do Sectoral Funds Work?
Different phases of the economy may be supportive of the growth of different sectors. Sector funds help you make the most of such opportunities by only investing in a particular sector. The fund manager of these schemes aims to invest in companies of a specific sector with growth potential. For example, a fund investing in the pharmaceuticals sector will seek to invest primarily in the top-quality businesses that operate in the pharma sector. Consequently, sector funds aim to benefit from the future performance of the sector it invests in.
What are the advantages of Sectoral Funds?
Targeted Allocation
Broad market mutual funds may diversify their holdings across sectors, but this prevents them from targeting a particular sector expected to perform in the long run. On the contrary, sectoral mutual funds focus on investing in only one sector that has the potential to grow in the future and, therefore, can give you a specifically targeted allocation to the booming sector.
Potentially Higher Returns
Sectoral funds’ targeted allocation can offer the possibility of earningrelatively higher returns when the underlying sector performs. But, as the contribution of the said sector may be lower in a scheme that diversifies across sectors, the returns driven by the sector’s performance may be lower too. This mainly happens due to cyclical nature of the sectors. Hence, this may suit those investors who have a definite sectoral/macro view of the economy.
Market cap diversification
These funds can invest in large, mid as well as small-cap companies. So, you may benefit from diversification across the market caps of the underlying sector.
Who should invest in Sector Funds?
As these funds do not diversify across multiple sectors to balance out the risks associated with a single sector, investors with a high-risk appetite and sound understanding can consider investing in sector funds. Also, the purpose of these funds is to benefit when the underlying sector eventually performs well. So, if you have a long-term investment horizon, you may invest in sectoral mutual funds. Additionally, if you have conviction in a particular sector and wish to participate in its growth journey, sector funds are suitable for you.
Things to Consider Before Investing in Sectoral Funds
Risk of concentration
The returns of a sector fund are solely dependent on the performance of a single sector. So, these funds can be risky as they do not aim for sectoral diversity to balance out the risks.
Future Prospects
As mentioned earlier, sector funds bank on the future performance of the underlying sector. Thus, it’s crucial to study the macro-economic conditions/future prospects of the said sector before considering investing in these funds.
Short-term Volatility
The equity market may experience volatility in the short term. So, sector funds are suitable for long-term goals only, as the underlying sector may only perform over some time.
Taxation on Sectoral Funds
Sector funds are taxed just like any other equity funds. They attract-
Short Term Capital Gains Tax of 15% if the investment is held for less than or equal to 12 months.
Long-Term Capital Gains Tax of 10% if the investment is held for more than 12 months. However, equity mutual funds tax on LTCG is exempt up to Rs. 1,00,000 p.a.
So, if you are looking to grow with your favourite or trending sector, sector funds can be your go-to option.
Disclaimer:
The sectors mentioned are not a recommendation to buy/sell in the said sectors. The information herein is meant only for general reading purposes and the views being expressed only constitute opinions and therefore cannot be considered as guidelines, recommendations or as a professional guide for the readers. The document has been prepared on the basis of publicly available information, internally developed data and other sources believed to be reliable. The sponsor, the Investment Manager, the Trustee or any of their directors, employees, associates or representatives (“entities & their associates”) do not assume any responsibility for, or warrant the accuracy, completeness, adequacy and reliability of such information. Recipients of this information are advised to rely on their own analysis, interpretations & investigations. Readers are also advised to seek independent professional advice in order to arrive at an informed investment decision. Entities & their affiliates including persons involved in the preparation or issuance of this material shall not be liable in any way for any direct, indirect, special, incidental, consequential, punitive or exemplary damages, including on account of lost profits arising from the information contained in this material. Recipient alone shall be fully responsible for any decision taken on the basis of this document.
Mutual Fund Investments are subject to market risks, read all the scheme related documents carefully.
