Mutual funds offer many diverse options to investors to invest in depending on their financial goals, risk appetite, investment horizon, etc. From equity to debt to gold, mutual funds offer different investment opportunities. One popular diversification instrument offered by mutual funds is sector funds. These allow investors to invest in a specific sector like banking, utility, energy, FMCG, etc.
Sector mutual funds, as mandated by market regulator Sebi, invest a minimum of 80 percent of its assets in a specific sector. For instance, in a banking sector fund, 80 percent of its assets will be banking stocks. Similarly in an FMCG sector fund, FMCG stocks will be in focus.
The stocks these funds invest in can be from different market capitalization. It allows investors to invest in the best-performing stocks of the specified sector.
While there is a lot of growth potential, these equity mutual funds can also be vulnerable to heavy losses in case of negative economic trends in the specified sector.
Like when the COVID-9 pandemic hit, sectors like auto, realty took a hit due to the lockdown. People were more focused on necessity items rather than buying cars and houses which lead to a major decline in these stocks. Since stocks of these sectors tanked, the sector funds also witnessed a sharp decline.
Broadly speaking, sector funds are classified into IT funds, Utility Funds, Healthcare funds, precious metals funds, Real estate funds, Banking funds, energy funds, etc.
Why should you invest?
Sector funds are suited for investors whose portfolio lacks exposure in any particular sector. It gives a great diversification opportunity to its investors. Instead of investing in selected stocks of a specific sector, these funds allow you to invest in the best-performing stocks of the sector in one place.
But an investor must be invested in a sector he/she has a good understanding of, so that he/she can forecast trends relating to the sector and buy and sell units of the fund accordingly. Also, since you are investing in just one sector, any sudden downturn in the sector can lead to heavy losses. So well-informed investors who have a high-risk appetite should only go for such funds.
You should also prefer sectors that have high growth potential and will be in trend for at least the next 5 years. One must note that the performance of such funds is more volatile than balanced funds or even index funds that have a more diverse portfolio. An investor should not invest more than 5-15 percent of his/her overall portfolio in a sector fund.
The net assets under the management of sectoral/thematic funds have jumped 79 percent to ₹1.1 lakh crore in April 2021 from ₹56,800 crore in April 2020. While most mutual funds investors advise investing in them for the long term, past performance data of sector funds shows that 1 year/2 year returns of these funds are better than the last 5 years.
Let's look at some funds that have given over 75 percent returns in the last one year and compare it with their 5-year returns.
However, it is important to note that one must never just depend on the past performances of funds to decide which one to invest in. Identifying future opportunities of a sector and potential trends will help you in choosing the better-suited sector for your portfolio.
You should also compare the performances of these funds with diversified funds, in order to choose the better fit fund for your portfolio.
An investor should only invest in sector funds if they are comfortable with the risks involved and have a good understanding of the sector. Before investing in a sector fund, it is important to research well about the fund, the fund house as well as the fund manager. It is always safer to go with a reputable fund house.
Also one must compare expense ratios with funds with similar themes before deciding on the fund. Another key aspect is analyzing the future growth opportunities of the sector. These are some key things to keep in mind before investing in a sector fund.