Sectoral mutual funds: Are these for you?

Are you considering mutual funds and wondering if sectoral funds are the right fit for your investment strategy? Sectoral funds can offer high returns by investing in particular industry sectors, but they come with higher risk due to lack of diversification. They might be suitable if you have a good understanding of the sector and are willing to take on the associated risks. To learn more about sectoral mutual funds and determine their suitability for reaching your goals, continue reading.  

Understanding sectoral mutual funds

Sectoral mutual funds, or sector funds, are equity funds that concentrate on investing in a particular industry or sector. Unlike diversified equity funds, which disseminate investments throughout distinct sectors, sectoral funds focus on a specific sector. This focused approach aims to capitalise on the growth potential of particular economic sectors, such as pharmaceuticals, technology, infrastructure, or banking.  

Benefits of Sectoral Mutual Funds

Three major benefits of sectoral mutual funds are -

• High returns in booming sectors

Sectoral funds can provide considerable returns when the selected sector performs well. For instance, during COVID, the pharmaceutical sector witnessed considerable growth, benefitting retail investors in pharma sectoral funds. When the sector witness growth, the companies within it often see their stock prices rise considerably. This translates into higher fund net asset values (NAVs) and potential capital gains for retail investors.  

• Focused investment

These funds offer concentrated exposure to a specific sector, permitting you to invest in sectors that line up with your market analysis and expectations. This concentrated investment strategy can be beneficial if you have strong convictions regarding the growth potential of a particular sector, depending on industry trends, technological advancements, regulatory changes, and other factors.  

• Tactical allocation

Sectoral funds are suitable for retail investors looking to make tactical allocations depending on the cyclical nature of sectors. Well-informed investors can time their investments to benefit from bust cycles and sectoral boom. For instance, a well-informed investor may choose to invest in technology sector funds during periods of rapid technological innovation or in energy sector funds when oil prices are anticipated to rise.  

Considerations before investing in sectoral mutual funds

Making specific considerations before investing in sectoral funds is crucial because of their higher risk due to lack of diversification. Two specific considerations to factor in are -

• Market timing

Successful sectoral investing often requires precise timing, which may be challenging even for experienced retail investors. Predicting the optimal entry and exit points for a sector requires an in-depth understanding of market trends and dynamics. Mistimed investments can lead to suboptimal returns or losses.  

• Long-term perspective

Sectoral investments are usually more effective when held for the long term. They might not be suitable for short-term goals or retail investors requiring liquidity. The growth potential of a sector often unfolds over several years, and fluctuations over the short term can affect the fund’s performance.  

Taxation of sectoral mutual funds

Taxation on sectoral mutual funds is the same as on equity funds –

• Short-term capital gains (STCG)

Gains from selling fund units within a year are taxed at 20 per cent. If you redeem your units within a year of purchase, the gains are considered short-term capital gains and are subject to a higher tax rate.

• Long-term capital gains (LTCG)

Gains from holding units for more than a year are free of tax up to ₹1.25 lakh annually. Gains surpassing this threshold are taxed at 12.50 percent. This tax benefit can make long-term investments in sectoral funds more attractive, as you can benefit from lower tax rates on considerable gains.  

Who should invest in sectoral mutual funds?

• High-risk takers

These funds are suitable for retail investors comfortable with high risk owing to their focused exposure. If you have a high-risk appetite and can withstand considerable losses in pursuit of higher returns, sectoral funds might be apt for you. A SIP calculator can assist you in planning and manage your investments systematically, ensuring that you can manage the inherent risks while pursuing potential high returns.  

• Active investors

Sectoral investments require active monitoring and a deep understanding of sector dynamics. Retail investors who are knowledgeable regarding specific industries and can remain updated with market trends and news are better positioned to make well-informed decisions.  

How to invest in sectoral mutual funds?

• Select a reputable fund house

Choose a well-chosen mutual fund house with a proven track record in managing sectoral funds. Look for fund houses with demonstrated expertise and success in managing sector-specific investments.  

• Choose the desired sector

Depending on your research and market outlook, select the sector you wish to invest in. Factor in parameters like economic trends, industry growth potential, technological advancements, and regulatory environment.

• Pick the correct fund

Within the selected sector, figure out a fund that is in line with your mutual fund investment goals. Consider factors like previous performance, expense ratio, and fund manager expertise. Assess the fund’s historical returns, experience of the fund manager and risk metrics in managing sectoral investments.  

• Allocate funds

Decide on a lumpsum investment or set up a systematic investment plan (SIP) for regular contributions. An SIP permits you to invest a fixed amount periodically, lowering the impact of market volatility through rupee cost averaging.  

• Assess your investment

Periodically, evaluate your fund’s performance and make adjustments. Track the scheme’s NAV, compare it with benchmarks, and assess the sector’s performance to ensure it is in alignment with your investment goals.  

• Remain Informed

Stay informed of sector and market developments. Active management and timely decisions are essential. Follow industry news, market trends, and economic indicators to make well-informed investment choices.

Ending note

Sectoral mutual funds provide a unique opportunity to capitalise on the growth potential of particular economic sectors. While they can generate high returns, they even entail higher risks. Evaluate your risk appetite level, investment goals and market knowledge before investing in sectoral funds.

These funds are best held long-term and must complement a diversified mutual fund investment strategy rather than being the sole focus of your investment portfolio. For savvy retail investors, sectoral funds can provide a strategic benefit in promising sectors, but they need careful consideration and active management.

(Devdiscourse's journalists were not involved in the production of this article. The facts and opinions appearing in the article do not reflect the views of Devdiscourse and Devdiscourse does not claim any responsibility for the same.)