A diversified portfolio helps investors tackle investment risks and ensure consistent medium to long-term returns. Here, investors can choose to diversify their portfolios by investing in asset classes like equity, debt, and gold. On the other hand, they can opt for investments in diverse sectors of the economy.

Wondering what the latter types of investment instruments are called? These are known as sectoral mutual funds in India. Read on to learn about the sector or sectoral funds in detail!

Sector or sectoral funds are sector-specific funds that focus on investing in stocks of companies belonging to one particular sector.

These are equity funds that mostly invest in stocks and equity segments of a particular segment or industry of the economy.

As per the Securities and Exchange Board of India (SEBI) guidelines, sectoral funds invest a minimum of 65% of their assets in a specific sector.

Now that individuals know the meaning of sectoral funds, let’s learn about other related details.

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There are no fixed types of sectoral funds. However, there can be different sector-wise mutual funds depending on the available sectors or industries. 

Popular sectors dominating the Indian economy include the following:

• Telecommunication
• Natural Resources (oil, gold, etc.)
• Aviation
• Technology
• Real Estate/Development
• Healthcare and nutrition
• Pharmaceuticals 

Equity mutual funds invest money in stocks of companies. Sector-wise mutual funds invest 80% of their money in stocks of companies belonging to the same sector or industry. 

A sector includes similar kinds of businesses under its umbrella that provide similar types of products. For instance, take the pharma sector, which has companies such as Cipla and Biocon operating in this sector. Therefore, a sectoral fund investing in the pharma sector will have a portfolio of businesses belonging to this specific sector. 

However, this particular fund will not only focus on investing in medicines but also in different areas like hospitals, diagnostics and many other related operations.  

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The essential features of sectoral mutual funds in India are discussed below:

• Concentrated: From the definition of a sectoral mutual fund, one can clearly understand that these fund types focus on particularly one sector of the market. Thus, there is no chance for diversification. To be precise, sectoral funds primarily depend on the performance of that chosen sector.
• Research-Intensive: Since investment in sectoral funds occurs in a single sector, fund managers need to conduct extensive research to identify the trends of that specific sector. Fund managers can predict the growth and performance of a sectoral fund only after such practice.
• Term: Sectoral funds can have small, medium, to long term. Usually, fund managers do not prefer small term investments. On the other hand, long-term sectoral fund investment allows a particular sector to grow and churn out maximum benefits over a long period of time.
• Hedge against Inflation: Sectoral funds can function as a hedge against inflation, given the chosen sector operates in a way that is inversely proportional to the economy.

Here is a list of benefits of investing in sectoral funds or sector fund:

• Investment Across Market Capitalisation: By investing in sectoral funds, investors can get exposure to a diversified portfolio where they can invest in equities of companies (belonging to a particular sector) across market capitalisation.

Investing in sectoral funds has the following risks:

• Investment Risk: As stated earlier, sectoral funds investment is concentrated in nature. It means the investment does not provide the scope for diversifying the portfolio. When an investment has lesser diversification, it will automatically be exposed to higher risk.
• Volatility Risk: Some sectoral funds have volatility risks meaning at times of market fluctuations. These funds can come under the direct influence of ups and downs. If a specific sector performs well in a particular market condition, it can generate profitable returns and vice versa.

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Investors must assess the following factors before investing in sectoral funds:

• Investment Goals: Investors must always be sure of their investment goals and make a decision accordingly. If investors have an investment horizon of a long time then they can find sectoral funds an ideal option. Wondering why? Any sector needs substantial time to grow, and so does the sectoral fund to generate profitable income. 
• Risk: To ensure guaranteed and profitable returns, investors must evaluate the risk factor of sectoral funds. Sectoral funds are confined within one sector. If that particular sector suffers from adverse market conditions, it can expose investors to high risks and potential loss.
• Exposure Limit: As sectoral funds possess high risk, they must not give much weightage to this fund in their portfolio.
• Expense Ratio: The expense ratio is an annual charge that Asset Management Companies (AMC) charge from investors for managing sectoral funds. Hence, investors must consider this factor before investing.
• Taxation: Sectoral funds are taxed as equity mutual funds. Subsequently, they have short-term and Long-Term Capital Gains tax. (LTCG tax) If investors sell the investment before 1 year, they will be classified as Short-Term Capital Gains (STCG tax) and have to pay 15% tax on these funds.

On the other hand, if investors hold a sectoral fund for less than 1 year, it will be classified as Long-Term Capital Gains (LTCG) tax.

Remember, if investors gain up to ₹ 1 lakh, they do not have to pay any tax. For gains of more than ₹ 1 lakh, investors have to pay 10% tax on them.

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Investors with a high-risk appetite and a minimum investment horizon of 3-5 years can invest in sectoral funds.

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Investors can invest sectoral funds offline via a broker (through a regular plan). Individuals willing to invest independently can do so by visiting the nearest AMC branch. Otherwise, they can invest via online investment platforms.

Reading the above information is not enough. Carefully analyse specific sectors and their trends in particular market conditions before investing in sectoral funds in India.