Investment Guide for Sectoral Funds

For investors who wish to concentrate on a particular business or industry, sectoral mutual funds are a great choice. However, one should be conscious of the potential dangers and restrictions when investing in sector mutual funds. Vardan Pandhare lays down some important guidelines that you could follow.

You would have recently noticed a staggering increase in the information technology (IT) industry. And now you are wondering whether there’s a way to benefit from this growth trend without actually having any core knowledge of this sector. Yes, definitely! You can invest in stocks of successful IT firms by investing in sector funds dedicated to information technology companies. Sector or sectoral mutual funds are nothing but equity-linked investments in a particular economic sector or industry.[EasyDNNnews:PaidContentStart]

A few examples of this industry are IT, FMCG, steel and coal. These funds make investments in businesses within particular industries with a range of market capitalisations and security classes. So, coming to the moot question, do you find the prospect of investing in sector-specific funds exciting? If so, then take into account the following factors before diversifying your portfolio by including sector-specific mutual funds.
 

Understanding Sectoral Mutual Funds

According to SEBI regulations, sector mutual funds must invest a minimum of 80 per cent of their assets in a certain sector. They concentrate on a certain industry, such as banking, healthcare, real estate or energy. A banking fund, for instance, solely invests in the equities of banks. Investors can invest in industries with a strong potential for growth through sector mutual funds. These mutual funds offer appealing returns, but typically only when investing at the right time. Investment in sector-specific funds must therefore be done at the right time. Also, the fund’s departure becomes significant.

Sectors do so because the business cycle affects them. The fund is impacted by the ups and downs of the business cycle. A good return on investment may result from picking strong growth sectors. A decline in the sector, however, might also result in large losses. That is mostly because there isn’t enough diversification. The assets are all allocated to a single sector. As a result, the fund’s volatility is often significant. A portfolio can be improved by using sector funds. One must, however, have the patience to ride out market cycles.
 

Sectoral Funds in India and Types

Let’s examine sector funds in the following eight categories to have a better understanding of what they are:

■ Infrastructure Funds : One sectoral fund that is lately attracting many eyeballs is the infrastructure mutual fund, which primarily invests its corpus in stocks of construction companies, capital goods, and metals sectors. According to statistics, in the year 2020 private investors spent 35 per cent of their investments in urban infrastructure. The best way to take advantage of the current market volatility is to embrace a phased approach to investing. One can do a systematic investment plan (SIP) on these infrastructure funds so that over a period the market turbulence works in your favour and the cost of holding also reduces substantially.

■ Financial Funds: These funds invest in businesses involved in the banking, insurance, mortgage and accountancy industries.

■ Technology Funds: These funds invest in companies in the technology industry, which covers those working in electronics, computers, information technology and associated goods and services.

■ Real Estate Funds: Investing in real estate funds allows investors with small capital to enter the real estate market. Investors have access to these funds for both income and growth potential.

■ Natural Resources: These funds are appropriate for long-term investors since the industry is frequently susceptible to long-term volatility. The funds are put to use in businesses engaged in forestry, the timber industry or the natural gas and oil sectors.

■ Precious Metals: Investing in precious metals firms that deal in materials like gold, silver, copper, palladium and platinum is possible through precious metals funds.

■ Healthcare Funds: These funds invest in pharmaceutical firms, for-profit hospitals, pathological labs and other similar businesses.
 

Investment Guide for Sectoral Mutual Funds

Investors should take the following elements into account when selecting a sector mutual fund:

■ Expense Ratio: The yearly fee that a mutual fund assesses to its investors is known as the expense ratio. To cut costs, investors can select a fund with a low expense ratio.

■ Fund Manager: Before investing in a sector mutual fund, investors should investigate the experience and track record of the fund manager.

■ Historical Performance: Investors should think about the fund’s previous performance and contrast it with that of other funds in the same industry.

■ Fund Size: A fund’s performance may be impacted by its size. Investors should pick a fund that is just the right size – not too tiny, nor too big.
 

Things to Assess
 

■ Not for the Novice: Sector funds do not fall under the umbrella of mutual funds, which are advised for all types of investors, especially those who are new to the financial markets. A sector fund purchase is a wager on the prospects of a certain industry, thus it may not be the best choice for novice investors. If you do decide to make a decision, do some thorough study beforehand.

■ Sector Trigger: Knowing sector drivers is important since investing in one sectoral fund against another that focuses on a different area is not the same thing. Before making an investment in a sector, you must understand what motivates that industry. You would be putting your money in unnecessary danger if you didn't understand the major factors and measures that influence a sector’s movement.

■ Diversification: Sector funds are concentrated due to the nature of their origination, but they can be utilised for purposeful diversification. Yet, the goal must be clear. You must have answers to the issues of which industry must be invested in and what portion of the entire portfolio should be placed in such a fund.

■ Portfolio’s Make-Up Verfication: Not all sectoral funds are created equal. There are significant variances in investment and stock quality even among investors in the same industry. Before you choose to spend your hardearned money, it will be vital for you to research these disparities and other issues.

■ Avoid Blind Date: Instead of relying on uninformed advice, thoroughly research the sectors and understand how their cycles operate. Due diligence is needed since a highly suggested industry could or might not be right for you.
 

Sector mutual funds may fill a significant need in a portfolio, but they will only be effective for you if you utilise them properly. In all other cases, investing in a diversified mutual fund is preferable.
 

Taxation on Sectoral Funds

The post-tax returns are what really count and knowing how sectoral funds are taxed can help you make that determination. Depending on how long the investment was kept, the capital gains obtained as a consequence of selling your sectoral fund are subject to tax. If you sell your investments within a year, the profits are considered short-term capital gains (STCG), and you must pay 15 per cent tax on them. The gains from any sectoral fund held for more than a year are categorised as long-term capital gains (LTCG) and are subject to taxation. Gains up to ₹1 lakh in a fiscal year are exempt from taxation. Gains over ₹1 lakh are subject to 10 per cent tax.
 

Target Investors

High-Risk Investors: As mentioned earlier, these funds invest in a distinctive sector and this lack of diversification means they tend to be riskier mutual funds available. Owing to this, investors who are comfortable with taking a high risk should consider investing in them. Active Investors: If you are investing for the first time, do not jump into sector funds right away. These funds are all about timing one’s entry and exit correctly, which is something that even skilled investors struggle with as it needs rigorous research about the sector. Active investors who are continuously up-to-date with the news and headlines can take a better call on which sector is going to perform well.
 

Tactical Allocation

Some sectors are considered to be cyclical sectors, as for example, the automotive sector. So, investors wanting exposure to businesses that are at the bottom of their cycle can make a great bargain by investing in sectoral funds. A shrewd investor can invest in a sector which is at the bottom of its cycle, and wait for the right time when it reaches its peak. When at the top, they can immediately sell to book profits.
 

Conclusion

Coming to the final question, should you enter sectoral mutual funds? To be specific, investing in sector funds isn’t a bad deal. Since sector mutual funds are highly specialised investments, it is crucial to comprehend the industry as a whole. Yet, you also need to accept the dangers involved. Also, you may want to consider how much exposure to a certain industry is good for your investment portfolio. One should not worry about missing out on a sector investing opportunity because diversified mutual funds frequently invest across many sectors that are performing well. They are an excellent substitute for pure sector plans. To sum up, you should only invest in sector funds if you have a thorough understanding of the business, can forecast a promising cycle for it and are at ease with its volatility. 

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