Sector funds are a type of mutual fund that invests primarily in specific industries, like technology or healthcare. They aim to capture growth within that particular sector. Investors are exposed to the performance and risks associated with that chosen industry.
A sector consists of similar businesses that offer somewhat the same type of product or
service. The Indian economy has several sectors, including information technology, banking, pharma, chemicals,
aviation, etc. These sectors keep evolving based on many factors and developments. For instance, the defence
sector may fare well when the Union Budget announces special aid or growth plans in the sector.
If you want to invest in such sector-focused opportunities, you can consider investing in sector
mutual funds. Also called sectoral mutual funds, these are equity funds that are required to invest at least 80%
of their total assets in the dedicated sector. Within the sector, these funds can invest in stocks with varying
market capitalisations. All in all, they give investors exposure to the best-performing stocks in a specified
sector.
Sector funds can be of various types, as follows:
Pharma sector funds: These invest in pharma stocks, biotechnology and life
science technology stocks, manufacturers of medical and healthcare stocks, etc.
Information Technology (IT) funds: These invest in companies relating to IT,
electronics, etc.
Banking and financial services funds: These invest in major Banking,
Financial Services and Insurance (BFSI) companies.
Auto sector mutual fund: This fund invests in auto sector companies, including
manufacturing and ancillary businesses.
Energy sector mutual fund: This fund invests in stocks of companies engaged or
related to the energy sector, whether in the production or exploration of alternative energy.
Since sectoral funds focus on a particular sector, they are exposed to a high risk of concentration. As such, in
a bearish market or in case of underperformance of a sector, the fund can run into significant losses. On the
other hand, if the sector has bright prospects, the fund can perform very well.
How Do Sector Funds Work?
A sector fund invests in securities of companies belonging to the same sector. A sector comprises different companies that offer the same types of products or services. For instance, in the Indian economy, there exist several sectors such as banking, information technology, chemicals, pharma, healthcare, and more. If you wish to invest in a mutual fund that invests capital in a specific sector, you may consider sector-oriented mutual funds. Sectors are constantly evolving and growing due to many factors.
Sectoral funds are essentially equity-based funds that are required to invest a minimum of 80% of their capital in the sector in question. Within a particular sector, sectoral funds can invest in equity of differing market capitalisations. Sectoral funds work to give investors exposure to potentially optimal performing equity within a certain sector.
Features of Sectoral Mutual Funds
Higher concentration risk: Sector funds limit their investment to a specific sector. As such, your portfolio’s performance is vulnerable to that sector’s performance.
Diversification: Though sectoral funds focus on a single sector, they can diversify by investing in stocks across market capitalisations within it.
Growth in the sector: Not all sectors grow at a similar pace, as they have different opportunities and limitations. For instance, the information technology sector disrupts at a faster pace compared to FMCG.
Peaks and plunges: Although sectors have phases of peaks and plunges, you can invest in sectoral funds regardless of the phase via SIP. This could help you benefit through compounding and cost averaging.
Long-term investments: Since sector funds are equity-oriented schemes, it is best to invest in them for a longer horizon to beat volatility in the short run.
Advantages of Investing in Sector Funds
High growth potential: Sector funds enjoy high growth potential when the underlying stocks of the chosen sector are performing well. Hence, your returns maximise.
Professional management: Like other mutual funds, professional fund managers manage sector funds too. Therefore, you can benefit from their expertise.
Long-term investment: Sector funds are excellent investments for long-term financial goals. Ideally, you should stay invested in these funds for over 5-7 years to fully reap the benefits.
Risks Involved in Sector Funds
Market risk: Since sectoral mutual funds invest in equity, they are exposed to market risks and volatility.
Liquidity risk: In case you wish to redeem your units in a sector downturn, the mutual fund house may find it difficult to find sellers to liquidate your holdings.
Low diversification risk: Sector funds focus on a specified sector, which limits the scope of diversification across other industries and asset classes.
Cyclical risk:The fund may be adversely impacted by the risk of business cycles or economic cycles. For example, after 2008, infrastructure had a significant downcycle, and after 2011, capital goods experienced a similar phase. Had you invested 50% of your portfolio in these funds because you were bullish on them, you would have incurred heavy losses. Therefore, it is best to diversify and take calculated risks, especially when it comes to investing in sectoral funds.
Factors To Consider Before Investing in Sector Mutual Funds
Mutual funds are typically designed to diversify your portfolio and sectoral funds aim to do this by investing their assets in a specific sector. Before you attempt to invest in sectoral funds, you need to consider the following:
Investors may need to conduct preliminary market research on the particular sector they are choosing to invest in before doing so as sector funds require you to take a chance on the prospect of a single industry. You would not want to make the mistake of placing all your eggs in one basket and exposing yourself to risk.
Whether you are new to investing or an experienced player, it is imperative that you grasp knowledge of the sector you choose to invest in so as to have a clue about its potential growth prospects. You should be aware of what drives particular sectors and how this takes place.
Consider your horizon of investment when you wish to invest in sector funds. Sectors differ in terms of their potential growth and various factors affect different sectors. Some sectors may grow faster than others, so investors must be prepared for long-term investment if required.
Think about your overall portfolio when you wish to invest in a sectoral fund. If your aim is portfolio diversification, you may contemplate a particular sector to invest in if you have securities and instruments that do not include this kind of investment.
Think about your own investment style and behaviour before you invest. Are you ready to take risks if it does affect your fund? Think of these things before you go ahead and invest.
Similar to any other mutual fund, you are able to invest in sectoral funds both during peaks and plunges via the route of a SIP (Systematic Investment Plan). Such systematic and regular investments over periods may help you benefit by cost averaging as well as compounding.
Who Should Invest in Sector Mutual Funds?
Requires professional expertise: Like other mutual funds, professional fund managers manage sector funds. So if you want to capitalise on a sector but aren’t sure about which stocks to choose, sectoral mutual funds could be a good option.
Can bear high risk: Sector mutual funds are highly risky not just because they are equity-oriented but also because they have a limited scope for diversification. However, if a sector does well, the sectoral fund can perform well too, and vice versa. So investors with high-risk tolerance should consider investing in such funds.
Needs exposure to a specific sector: You can consider investing in a particular sector fund if your overall investment portfolio lacks exposure to that.
Taxability of Sector Funds
Sector funds are treated as equity funds for tax purposes.
Here’s how capital gains from selling sector fund units are taxed:
Short-term Capital Gains (STCG): Gains on sector fund units sold within a year of buying are taxed at 15% plus applicable cess.
Long-term Capital Gains (LTCG): Gains up to Rs. 1 lakh per year on selling sectoral fund units after a year of holding them are tax-free. Gains beyond this limit are taxed at 10% with no indexation benefit.
Besides, dividends earned on sector funds are added to the investor’s taxable income and taxed at the rate as per the income tax slab. There is also a 10% TDS on dividend amount exceeding Rs. 5000 in a financial year.
How To Invest in Sector Funds?
Investing in a Sector Fund is hassle-free when done through your Angel One account. You just have to follow these simple steps:
Step 1: Log in to your Angel One account.
Note: In case you do not have an account with Angel One, you can open a demat account with us in under a few minutes by submitting the necessary documents.
Step 2: Determine a Sector Fund fund that suits your needs and risk profile. You can learn more about each Sector Fund on the Angel One app. Things to consider at this stage are:
Search for the fund you want to invest in.
Analyse the fund’s past performance, tax incidence, and the sectors and companies it invests in. You can also calculate the potential returns using the calculator.
Evaluate the fund’s level of risk, its ratings and expense ratio.
Step 3: Once you finalise the Sector Funds you want to invest in, open your Angel One account, go to the Mutual Funds section, and look for it.
Decide whether you want to invest via SIP or make a one-time investment
Decide your monthly SIP date. Now, enter the amount you want to invest and choose the payment mode.
After placing the order, you can create an AutoPay to make hassle-free future instalments in case of SIP investments.
The above-mentioned top funds are for informational purposes only, and are not recommendations. The funds are based on 5-yr CAGR, which is subject to change frequently. Check out real-time data on Angel One.
Tata Digital India Fund
Focused on the technology sector, Tata Digital India Fund has an AUM of ₹6,765.81 crore. It has given a 5-year CAGR of 22.44%. This sectoral mutual fund has an exit load of 0.25% and an expense ratio of 0.31%. Tata Digital India Fund tracks NIFTY IT – TRI. The fund has 79.23% large-cap holdings, 7.47% mid-cap holdings and 5.35% small-cap holdings.
ICICI Pru Technology Fund
This sectoral fund is also technology-focused. It has an AUM of ₹9,091.67 crore. The fund has given a 5-yr CAGR of 21.79%. S&P BSE TECk Index – TRI is the benchmark. The fund has 80.19% large-cap holdings, 6.81% mid-cap holdings and 7.27% small-cap holdings. ICICI Pru Technology Fund has an expense ratio of 0.98% and an exit load is 1.00%.
SBI Technology Opp Fund
A technology-focused sectoral fund, this scheme has an AUM of ₹2,879.97 crore. It has an expense ratio of 0.87% and an exit load of 0.50%. S&P BSE TECk Index – TRI is the benchmark index. This sectoral mutual fund has no lock-in period. SBI Technology Opp Fund has 66.41% large-cap holdings, 11.61% mid-cap holdings, and 3.6% small-cap holdings.
Aditya Birla SL Digital India Fund
The Aditya Birla Sun Life Mutual Fund is another technology-focused sectoral fund. With an AUM of ₹3,338.13 crore, the fund has an expense ratio of 0.88 and an exit load of 1.00%. It aims to replicate the performance of the S&P BSE TECk Index – TRI. Aditya Birla SL Digital India Fund has 65.37% large-cap holdings, 14.02% mid-cap holdings, and 13.00% small-cap holdings.
Quant Infrastructure Fund
Having an AUM of ₹839.69 crore, Quant Infrastructure Fund is an infrastructure-focused fund. It tracks Nifty Infrastructure – TRI. The fund has an expense ratio of 0.64% and an exit load of 0.50%. Quant Infrastructure Fund has invested 65.65% of its assets in large-cap holdings, 10.77% in mid-cap holdings, and 22.19% in small-cap holdings.
Yes. Sector funds are high risk as they invest majorly in one sector. If the sector happens to underperform for some reason, you can incur significant losses. Therefore, it is best to diversify your overall investment portfolio.
Should I invest in sector mutual funds?
In case you are bullish on a particular sector, you can do a thorough analysis and then decide whether or not to invest in it. Ensure that you have a high-risk tolerance and a length investment horizon of 5-7 years.
What are the expected returns of sector funds?
Sector funds have the potential to generate benchmark-beating or significant returns; however, it depends on their growth prospects, the fund manager’s skill, and economic conditions. For instance, Tata Digital India Fund has given a 5-yr CAGR of 22.44%, while ICICI Pru Technology Fund has given 21.79%.
What are the risks involved in investing in sector funds?
Sectoral funds are exposed to market risks and volatility. Additionally, these funds can also face liquidity issues in case of a sector downturn. Moreover, sector funds suffer from low diversification risk as they focus on a specified sector, limiting the scope of making up for losses from the gains of other industries.
Are sector funds taxable?
Sector funds are treated like equity funds. While short-term capital gains are taxed at 15% plus cess, long-term capital gains are tax-free up to Rs. 1 lakh per year. However, gains beyond this limit are taxed at 10% with no indexation benefit.
How much money should I invest in sector funds?
According to Warren Buffett, you should only consider investing in a sector if you understand it and have confidence that it will generate positive results. He further says not more than 10% of your portfolio should be invested in a particular sector.
