Sectoral funds, as the name is suggestive enough, are the funds that invest in a particular sector. These funds are a type of equity funds that invest across capitalizations of a specific industry that is expected to grow to accumulate a good corpus. Undoubtedly, sectoral funds have the capacity to give benchmark-beating returns in a bull market where the trend favors a certain sector but it also comes with huge risks. If the underlying sector fails to perform as expected and the losses magnify manifold in a bearish trend with no signs of uprise, the returns can turn upside down.
How Sectoral Funds Work?
Fund managers of sectoral funds allocate the fund corpus majorly in equities and equity-related instruments of companies of any given sector. For example, they may invest in sectors of pharmaceuticals, banking, FMCG, IT (Information Technology), etc. The fund money is invested in stocks of pan capital sizes, that is, they invest in shares of large companies, medium-sized and small ones altogether. The objective is to narrow down the investment of the fund to tap the growth of a specific sector/industry at accurate timings.
Fund managers carefully observe the market trend, the stock performances, and the growth potential of various industries. They invest in those sectors that are expected to rise exponentially in the near future and investing in them can augment wealth creation. If the timing is perfect, they can give huge results but simultaneously they are highly vulnerable to market risks and concentration risks. It is important for financial experts to be confident about the industry’s future boom and to time the market before investing.
As sectoral funds can be defined as sector-specific funds, the fundamental features of these funds are-
These funds are focused on one particular sector. On the basis of the industry type, the sectoral funds can be categorized into various kinds. It is evident that these funds are not diverse and hence, are largely dependent on the performance of the industry they focus on.
- High Returns
Sectoral funds can offer high returns as they are equity funds. According to the SEBI mandate, about 80% is invested in equity instruments. Moreover, these funds are all about cashing upon the right opportunity to earn from the growing sectors. Sectors are cyclic in nature and all sectors are not performing in tandem in an economy. So, with good research and analysis, investors can judge the right sector that can perform well and choose the sectoral funds to meet their financial requirements.
- High Risk
These funds are one of the riskiest investments for multiple reasons. One, being an equity fund, they are subject to market volatility and carry market risks. Two, concentrating on a particular sector gives lesser diversity and makes them riskier associating with the concentration risks. If the fund goes into loss, selling off the stock securities will not garner enough corpus putting investors at liquidity risk as well.
Needless to say, sectoral funds being equity funds are tax-treated alike. If units are redeemed within a year, which counts as short-term capital gains (STCG), these are taxed at 15% plus the applicable cess. Long-term gains (LTCG) are the capital gains when the fund is redeemed after the minimum holding period of a year. They are taxed at a flat rate of 10% after the prescribed limit of Rs. 1 Lakh which is tax-free. There are no indexation benefits.
Should You Invest in Sectoral Funds?
Whether you should invest in sectoral funds or not depends on your financial goals, investment horizon, and risk appetite. You may invest in sectoral funds, keeping in mind the high risks they carry, for the following advantages they have:
- They can be really rewarding if investors hit the right spot. They can gain high returns when a sector is giving an overwhelming performance in the stock market, sometimes higher than diverse portfolios. All you need to do is invest at the right time
- Although sectoral funds are not diverse when it comes to asset classes or sectors and industries, it is diverse when it comes to company size. They invest in multiple holdings of all types of market capitalizations so as to balance the portfolio. Even if some stocks fail to perform, the others outweigh them
- Can meet the long-term financial goals of the investors by providing inflation-beating returns. These funds can be added to the portfolio to take benefit of a growing sector
Wrapping it up:
Sectoral funds are mutual funds that invest largely in the equities of companies belonging to one sector or industry. Although they invest in diversified capital sizes of the stocks, they are sharply focused when it comes to the sector. This makes them highly rewarding and risky at the same time. While they can provide high yielding when the sector has great growth potential, they are equally vulnerable to market volatility. Suitable for high-risk takers aiming at corpus creation in the long run, investors must bear in mind that these funds are characterized by volatility and concentration risks. Hence, it is advisable that astute investors should invest in sectoral funds rather than beginners.