Should you invest in Sector mutual funds?

Sector mutual funds are equity schemes, which invest in a particular sector of the economy. So, now, the question arises as to how these funds are different from equity mutual fund schemes?  

Equity mutual fund schemes invest in the stocks of companies from various sectors of the economy whereas sectoral mutual fund schemes invest in a specific sector of the economy. Equity mutual fund schemes offer diversification over different sectors, where sector mutual funds fail to provide. Sectoral mutual fund schemes offer diversification by investing in different companies of a particular sector. Sector funds have an idiosyncratic risk (is a type of investment risk that is prevalent to an individual asset such as a particular company’s stock, or a group of assets like particular sectors stocks, etc). This type of risk is also known as unsystematic risk (a risk that is unique to a specific company or industry). These types of risks can be mitigated through diversification; however, investing in a sectoral fund, which has a high-risk potential and more volatility, is a focussed investment that offers no economic diversification. 

How do sectoral funds function? 

Sectoral funds offer investors to have an exposure to a specific sector of the Indian economy by investing all their money in the companies of the same sector. It also gives an opportunity to enjoy optimal returns, which have great potential to grow in the near future. Sectoral funds are routes that are built with the aim of helping investors grab such opportunities and invest. Indian economy consists of various sectors such as finance, technology, healthcare, real estate, natural resources, communication, and many more. These funds invest in similar businesses of a particular sector; for example, take banking sector: It consists of companies like HDFC Bank, ICICI Bank, Axis Bank, SBI, etc. Similarly, take technology sector, which consists of companies such as Infosys, Wipro, Persistent Systems, TCS, etc. that invests in all sizes i.e. from small-cap to large-cap companies. 

Things to be considered before investing in these funds: 

Investors having high-risk appetite: These funds are risky in nature; as mentioned above, they invest in a particular sector of the economy, which limits diversification. As sectors are cyclical in nature, they can outperform as well as underperform. Investors, who are willing to take higher risk, can choose to invest in these funds. Risker the investment scheme, the higher returns you will receive. 

Investors should have clear investment goals: Sectoral funds are long-term investment schemes. For investors, who want to make most of their investment in these funds, their investment horizon should be at least 4-5 years. 

Expense ratio: Investors should be clear about these expenses before investing in these types of funds. The expense ratio can be quite high as these funds are actively managed funds.

Taxation: The capital gains you earn after selling your sectoral fund is taxed according to the following parameters: 

• Short-term capital gains (STCG): Capital gains will be taxed at the rate of 15 per cent if you sell your investment within a year. 
• Long-term capital gains (LTCG): Capital gains will be exempted up to Rs 1 lakh while above Rs 1 lakh, it will be taxed at the rate of 10 per cent if you sell your investment after 1 year. 

The following chart shows the top-performing sector funds based on the past 3-year and 5-year returns: