Sector Mutual Funds: Meaning, Types & Top 10 Sectoral Funds in India
Sector Mutual Funds are equity mutual funds that invest in stocks of a particular sector or industry. This includes IT (information technology), pharmaceuticals, energy, banking, telecom, FMCG sectors and more. These mutual funds carry higher concentration risks than other equity funds as their entire portfolio is exposed to a specific sector. They also offer negligible diversification and are suitable only for highly aggressive investors.
Want to invest in a sector mutual fund? Then, take a deep dive into how sector funds work, types, risks vs. rewards and factors to consider before investing in Sector Mutual Funds. Read on!
What Are Sector Mutual Funds and How do they Work?
Sector funds are open-ended equity funds that invest at least 80% of their assets in equities and equity-related instruments of a specific sector. As their portfolio is entirely concentrated in a particular sector, they carry a high degree of risks. Their performance is also wholly dependent on the economic state of their sector.
The economy consists of different industrial sectors such as technology, pharma, natural resources etc., which perform differently. At any point, some of these sectors may show outstanding financial performance over others. Sector equity funds aim to help investors capitalise on such opportunities.
Sectoral funds invest in similar companies that offer the same products/services (more or less). For example, a pharma sectoral fund will invest in companies that manufacture medicine and related companies like hospitals and diagnostic centres. These mutual funds invest in the same sector across all market capitalisations (i.e. large-cap, mid-cap and small-cap).
Types of Sector Mutual Funds in India
- Technology Funds: These mutual funds focus mainly on electronics and IT companies.
- Financial Funds: It allows investors to invest in stocks of companies in the financial industry. This includes banks, insurance companies, investment companies, accounting firms, etc.
- Natural Resources Funds: These focus on energy, forestry, oil and natural gas and timber-related industries. It works well for investors looking for long-term growth.
- Precious Metal Funds: Such sector funds provide investors with exposure to gains in precious metals such as gold, silver, platinum, palladium etc.
- Real Estate: It allows small investors to participate in the real estate market for both income and growth benefits.
- Communication Funds: These invest primarily in the telecommunication sector and other internet-related companies.
- Utility Funds: Such mutual funds aim to provide steady dividends through investments in the utility sector.
- Healthcare Funds: These invest in pharmaceutical companies and for-profit healthcare institutions, lab chains and biotechnology firms. These also invest in companies engaged in the research of breakthroughs and advances in the industry.
- FMCG Funds: Such sector funds invest in companies in the fast-moving commodity goods (FMCG) industry.
Top 10 Sectoral Mutual Funds in India
The list below showcases the returns generated by the top sectoral funds over the last 3 years:
| Sectoral Funds | Returns in 3 Years |
| ICICI Prudential Technology Fund – Direct Plan – Growth | 43.80% |
| Aditya Birla Sun Life Digital India Fund – Direct Plan – Growth | 42.71% |
| Tata Digital India Fund – Direct Plan – Growth | 41.80% |
| Quant Infrastructure Fund – Direct Plan – Growth | 40.11% |
| SBI Technology Opportunities Fund – Direct Plan – Growth | 38.71% |
| Quant Consumption Fund – Direct Plan – Growth | 34.37% |
| Franklin India Technology Fund – Direct Plan – Growth | 33.62% |
| DSP Healthcare Fund – Direct Plan – Growth | 33.41% |
| Mirae Asset Healthcare Fund – Direct Plan – Growth | 33.35% |
| Tata Resources & Energy Fund – Direct Plan – Growth | 31.15% |
Why Should You Invest in Thematic Funds?
The best sectoral mutual funds invest in the top-performing companies of the same industry. You should invest in these funds because of the following reasons:
- Substantial returns
If a sector performs well, the fund related to that sector can deliver substantial returns. Each sector follows a cyclical pattern, in which they show good performance for a fixed tenure before facing a decline. Fund managers invest during the downfall period to gain immensely as the sector flourishes later.
- Long-term gains
The thematic funds may take time to showcase their actual potential. Such mutual fund schemes can assist individuals in achieving their long-term financial goals, such as building a retirement fund, financing the expenses related to marriage or child’s education.
Also Read
However, if you want a mutual fund that provides more diversification by investing in stocks of different sectors, you can check out some options, such as the Navi Large Cap fund offered by Navi mutual fund.
You can start investing in the Navi Nifty 50 and other Navi Mutual Funds through Zerodha, Paytm Money and Groww, to name a few.
Who Should Invest in Sectoral Funds?
- Highly Aggressive Investors: Sector funds are one of the riskiest mutual funds. Investors need to be comfortable with high risks for their investments. These funds are appropriate only for highly aggressive investors.
- Well-Informed Investors: Investing in sector funds requires you to carefully time your entry and exit, which even experienced investors may struggle with. In addition, investors need to keep abreast of news about the sector and do rigorous research to make better investment decisions.
- Investors Looking for a Tactical Allocation: Experienced investors with in-depth knowledge about a sector and high risk-appetite can benefit from the cyclical nature of sector funds. They can invest in a sector fund at the bottom of its cycle and exit when it reaches a peak.
Risk vs Rewards of Sector Funds
As sectoral funds invest heavily in one sector, its entire performance is fully dependent on the sector’s performance. Besides its concentration risk, a lack of diversification makes this one of the riskiest mutual funds.
Sector funds are exposed to market fluctuations and, thus, volatile in nature, just like stocks. Their returns are unpredictable and prone to cyclical changes as all sectors move differently in the economy. They are also slightly more expensive compared to other mutual funds as the funds have smaller economies of scale.
The returns from sectoral funds are similarly dependent on the individual sector’s performance. If you are an experienced and knowledgeable investor, it is possible for you to get exceptional returns. To do this, you have to take advantage of their cyclical nature and invest in the right fund at the right time.
Factors to Consider before Investing in Sector Funds
Given are some tips that you will want to consider before investing in sectoral funds:
- Assess your investment goals: Sector funds work best for long-term financial goals like funding children’s education, building a retirement corpus, etc. You may need to have an investment horizon of 5 to 10 years for investing in these equity funds. Investors with a short-term investment horizon will face considerably more risks.
- Have high-risk appetite: Sectoral funds are concentrated investments that put all their eggs in one basket. Investors should be prepared for the high risk associated with these mutual fund schemes.
- Limit your exposure: Investors may want to have a diversified portfolio with other mutual funds before considering sector funds. Since their risks are incredibly high, you should limit your exposure to sectoral funds.
- Take into account various expenses: AMCs (Asset Management Companies) charge a fee called the expense ratio to cover their administrative and operating expenses. Since sector funds impose higher sales charges and annual expenses, you should check the expense ratio to make sure it does not impact your returns significantly.
Taxation of Sector-based Funds
If you are looking for the best sectoral mutual funds, you need to know about the taxes involved.
- Long-term capital gains
If an investor holds units in a sector fund for 1 year and above, he/she earns long-term capital gains (LTCG). Such gains of up to Rs. 1 lakh are tax-free during a financial year. However, 10% tax is chargeable on returns above this threshold. There are no indexation benefits in this case.
- Short-term capital gains
In case an investor holds units in a sectoral fund for less than 1 year, the returns generated are referred to as short-term capital gains. A tax rate of 15% is applicable in such cases.
Final Word
Sectoral or sector funds are highly risky due to the concentration of their assets in one sector. They are also quite volatile and can show sudden gains or losses. Before investing in such mutual fund schemes make sure to consider certain aspects like risk appetite, investment time horizon, financial goals, the experience of the fund manager, past performance of the mutual fund scheme, etc.
FAQs on Sector Mutual Funds
Ans: No, such tax benefits are not available in the case of sectoral funds. However, one can claim tax deductions of up to ₹ 1.5 lakh by allocating his/her funds to ELSS funds under Section 80C of the Income Tax Act, 1961.
Ans: Yes, there are sectoral funds that primarily invest in consumer discretionary stocks. Companies belonging to this sector of the economy sell products that are not required daily. These stocks perform better when consumers are spending more, and the economy is prospering.
Ans: Sectoral equity funds invest in shares of small-cap, mid-cap and large-cap companies in a particular sector of the economy. As per SEBI guidelines, fund managers of thematic funds require allocating 80% of the total assets in stocks of a specific sector.
Ans: A direct plan in mutual funds refers to schemes that are directly made available to investors by the fund house. It does not involve any distributor or broker. Since such investments do not engage third parties, AMCs do not need to pay any commission.
Ans: All industries and sectors do not perform equally at the same time. This is the cyclical nature of economic sectors, where certain industries may do well at one time and worse during another cycle. Therefore, investors in sectoral funds need to catch the right cycle and exit it to earn high returns.
Ans: No, thematic mutual funds invest at least 80% of their fund corpus in stocks of a particular theme instead of a sector. Thus, they have a broader base than sector funds and offer more diversification. Thematic funds invest in stocks of different sectors based on a common theme. Examples of these funds include consumption funds and special opportunities funds focusing on IPOs, mergers etc.
Ans: Dividends from sector funds, like any other equity funds, will be added to the taxpayer’s overall income and taxed as per applicable tax slabs.
STCG (short-term capital gains) tax of 15% is applicable if the holding period is less than a year. On the other hand, LTCG (long-term capital gains) tax will be levied when you sell the mutual fund units after 12 months. Long term capital gains are taxed at a 10% rate; keep in mind that LTCG of up to Rs. 1 lakh is tax-free.
Ans: Investors need an in-depth understanding of a certain sector to cash in on its opportunities. You will need to constantly keep ahead of the latest news and headlines from the sector. You may also want to do rigorous research to find the right time of entry and exit.
Ans: Yes, sector funds are useful for increasing your portfolio’s exposure to a specific sector. So, investors can use them to hedge their portfolios. For example, if energy prices suddenly surge, various other sectors will experience losses, but an energy sector fund will experience growth.
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Disclaimer: Mutual Fund investments are subject to market risks, read all scheme-related documents carefully.
This article has been prepared on the basis of internal data, publicly available information and other sources believed to be reliable. The information contained in this article is for general purposes only and not a complete disclosure of every material fact. It should not be construed as investment advice to any party. The article does not warrant the completeness or accuracy of the information and disclaims all liabilities, losses and damages arising out of the use of this information. Readers shall be fully liable/responsible for any decision taken on the basis of this article.
