Sectoral mutual funds: Good or bad for your portfolio?

Sectoral mutual funds: Ready to chase high rewards with high risk? Sectoral mutual funds could be your match if you're comfortable with volatility and have a sharp understanding of specific industries. These funds focus on particular sectors, offering the potential for significant gains, but be prepared for the ups and downs that come with sector-specific investments.

What are sectoral mutual funds?

Sectoral mutual funds are investment vehicles that focus exclusively on specific sectors of the economy, such as technology, healthcare, or energy. Unlike diversified mutual funds that spread investments across various sectors to mitigate risk, sectoral funds target one particular area, aiming to capitalise on sector-specific growth opportunities.

Sectoral mutual funds pool investors' money to invest primarily in stocks from a particular industry or sector. For instance, a technology sector mutual fund would primarily invest in companies like Apple, Microsoft, or Nvidia. These funds are managed by professional fund managers who select stocks within the chosen sector based on their growth potential and market trends.

Types of sectoral funds

Sectoral mutual funds can be categorised based on the specific sectors or industries they focus on. Here are some common types:

• Technology Sector Funds: Invest in technology companies, including those involved in software, hardware, semiconductors, and IT services.
• Healthcare and Biotechnology Funds: Focus on healthcare providers, pharmaceuticals, biotechnology firms, and medical devices.
• Energy Sector Funds: Target companies in the energy sector, including oil, gas, and renewable energy sources.
• Financial Services Funds: Invest in banks, insurance companies, investment firms, and other financial institutions.
• Consumer Discretionary Funds: Concentrate on companies that produce non-essential goods and services, such as retail, entertainment, and luxury items.
• Consumer Staples Funds: Invest in companies that produce essential goods and services, including food, beverages, and household products.
• Industrial Funds: Focus on industries such as manufacturing, construction, transportation, and aerospace.
• Utilities Funds: Target companies providing essential services like electricity, water, and natural gas.
• Real Estate Funds: Invest in real estate investment trusts (REITs) and other real estate-related assets.
• Materials Funds: Focus on companies involved in the extraction and processing of raw materials, including metals, chemicals, and forestry products.
• Telecommunications Funds: Invest in companies providing communication services, including telecommunications, internet services, and media.
• Green Energy Funds: Target investments in renewable energy sources and technologies that focus on sustainability and reducing environmental impact.
• Emerging Markets Funds: Focus on sectors within emerging markets, such as technology, consumer goods, and infrastructure.

What makes sectoral funds stand out?

• Focused Investment: Unlike diversified funds, sectoral mutual funds concentrate their investments in one industry. This focus can lead to higher returns if the sector performs well but also comes with increased risk if the sector underperforms.
• High Volatility: Due to their concentrated nature, sectoral funds can exhibit significant volatility. Economic downturns or sector-specific issues can heavily impact performance, making them more volatile compared to diversified funds.
• Potential for High Returns: If a particular sector is experiencing a boom, sectoral funds can deliver substantial returns. For instance, during the technology boom of the late 1990s, tech-focused funds saw impressive gains.
• Expert Management: These funds are managed by experts who specialise in the chosen sector. Their deep knowledge can potentially lead to better stock selection and enhanced returns.

Risks and considerations

• Sector-specific risks: Investing in a single sector exposes investors to risks unique to that industry. For example, regulatory changes in the healthcare sector or fluctuations in oil prices for energy sectors can significantly affect fund performance.
• Economic cyclicality: Some sectors are more cyclical than others. For instance, consumer discretionary stocks may be more affected by economic downturns compared to consumer staples.
• Lack of diversification: The primary risk associated with sectoral funds is the lack of diversification. If the selected sector suffers, the entire fund's performance can be adversely affected.
• Market timing: Successfully investing in sectoral funds often requires accurate market timing and sector analysis. Investors need to predict which sectors will perform well and invest accordingly.

Ravi Singh, SVP - Retail Research at Religare Broking Ltd, shared his insights with Republic Business.

“Technology sector funds are becoming increasingly popular as investors seek to capitaliSe on advancements in AI, cloud computing, and cybersecurity. These funds are well-positioned to benefit from the ongoing digital transformation. The healthcare and biotechnology sectors are also garnering attention, driven by recent global health crises and innovations in treatment, with a focus on aging populations further fueling this interest," Singh said.

"Additionally, green energy funds are attracting considerable investment due to rising environmental awareness, supported by government incentives and growing consumer demand for renewable energy and sustainable technologies,” he added.

Siddharth Maurya, Founder & Managing Director of Vibhavangal Anukulakara Private Limited, provides the following investment advice:

“To make informed investments in sectoral funds, start by conducting thorough research on the sector of interest. It’s crucial to understand the sector’s growth potential, associated risks, and current market conditions. Evaluate the fund manager’s expertise, as their experience and track record can significantly influence the fund’s performance," Siddharth Maurya, Founder & MD, Vibhavangal Anukulakara advised.

"Be mindful of the fees associated with sectoral funds, which are often higher than those for diversified funds; understanding these fees and their impact on returns is essential. Finally, regularly monitor the fund’s performance and stay updated on sector-specific developments to make timely and informed investment decisions,” Maurya added.

Sectoral mutual funds offer a targeted investment approach that can yield high returns if the chosen sector performs well. 

However, they come with increased risks and volatility. Investors need to balance their portfolios with diversified investments and stay informed about sector-specific trends and risks. For those willing to take on higher risk for the potential of higher rewards, sectoral funds can be a compelling addition to their investment strategy.