Sector Funds: Should you own one?

The focus has a magical power and it helps you attain your business, financial and personal goals. Investing is no different and the power of focus can be best explained with investment in sector funds. These funds invest only in a particular sector of the economy such as infrastructure, bank, energy, real estate etc. Investing in sector funds can generate exceptional returns both upward as well as downward. For example, technology dedicated funds of late 90’s and early 2000 were the best performing funds. Similarly, during the bull run of 2003-2007, infrastructure fund remained one of the most performing funds.  The following year both the sector funds (IT in 2000 and Infra in 2008) were worst performing funds.

These funds help an investor in two ways. First, it helps them to balance their exposure to a sector which is underrepresented in their portfolio. Second, they can add a zing to your entire portfolio, if your timing of entry and exit to these funds are right. They present a serious upside potential to an investor who has the stomach for risk. 

Sector funds are launched to take advantage of different phases of economic and business cycle. Different sectors of the economy at different point of the business cycle are impacted differently and hence stock performance. For example, financial and transportation sector is the initial gainer, when economy cycle gains traction and make up-move from the trough. While utilities gain once the business cycle starts descending from the peak. 

Therefore, someone having the understanding of these macroeconomic events (economic and business cycle) can exploit the opportunity through sector rotation strategy. Therefore, investment in sector fund can help you increase overall portfolio return. 

Nevertheless, there are some issues with such strategy. First, most of the investors enter the sector fund only after it has run up significantly. Second, once they have entered these funds they do not know when to exit. Besides, they are not sure about the amount of exposure they need to have in these funds. 

The following guidelines will help you manage risk while investing in sector funds 

Limit your exposure to sector funds. The exact percentage will depend upon individual risk appetite; however, it should not exceed more than 10% of your portfolio 

The best way to make most out of sector funds is when they have just started to show better performance. Latecomers may burn their hands and suffer losses. 

Sometimes you have to wait for a longer period to reap the benefit of investing in sector funds. 

Last but not the least, you should have an exit strategy. Decide what is your expected return and exit the fund once you achieve that, even if it means forgoing some potential gains.