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Sector Funds – Are These a Good Investment?

Highlights

  • Is it worth investing in a sector fund?
  • Maybe not, if you seek diversification - Read this post to decide better!

Sector funds, also known as sectoral funds, are those mutual funds that invest only in stocks of one sector. There are different kinds of sector funds such as FMCG, Pharma, Banking, Technology, Energy, etc. Let us take the example of a banking sector fund. This fund will only buy banking stocks, such as HDFC, ICICI, Kotak, SBI, IndusInd, and other banks will be a part of this portfolio. These funds have been around for a long time and are classified under the equity fund category.

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If you understand how a sector works and see high growth potential, you might be tempted to invest in that fund. Before you do so, let us look at the various aspects of investing in sector funds.

Pros & Cons of Investing in Sector Funds

  • Sector funds carry a high risk, in fact, these are among the riskiest amongst all equity funds. This is because you are betting on one sector to do well and deliver returns, and if it does not, your portfolio will suffer losses.
  • Unlike other equity funds, these are not diversified – you are putting all eggs in one basket thereby not availing the benefit of diversification.
  • Entry and exit become important since different sectors do well in different cycles. It is important to be on the right end when that cycle is starting and ending.
  • The role of a fund manager’s expertise becomes limited in a sector fund, unlike a diversified equity fund where a fund manager has to track and review different sectors. Here, the fund is constrained by investing in a certain sector that would have only a handful of good stocks.
  • Returns could be outsized from sector funds if the timing is right, these could outperform other equity funds by a huge margin but the same would be true in case that sector underperforms.
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From a layman’s perspective, it is very difficult to identify that one sector which will do well, the same can be understood by looking at the returns from different sector funds over a period. Let us see through this chart:

Time PeriodBest SectorsReturns (IN %)
Last 1 monthEnergy11.99
Last 1 yearPharmaceuticals35.47
Last 3 yearsTechnology12.99
Last 10 yearsMNC’s13.38

As you can see in different periods there are different sectors which are the best performing ones. These keep changing based on the fundamentals of sectors and the economic cycles. It is extremely difficult to pick one or two and invest your entire money in those.

Should You Invest in Sector Funds?

In our view, it is advisable to stick to diversified equity funds, these could be multi-cap, large-cap, mid-cap, or small-cap basis your risk profile. If you have a very strong view of a sector and have done thorough research, you can buy about 5-10% of your portfolio in that sector but buying more would be risky. Also, when investing in diversified funds, one can anyways avail benefits of the best sectors since fund managers keep rotating among these sectors in varying percentages. Usually, sectors that are slated to do well have the highest weightage in mutual fund portfolios.

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