Sector Funds: Definition, benefits, and comparison

Sector funds are mutual funds that invest in companies that belong to a specific sector of the economy. Sectors like Healthcare, Finance, Real Estate, Energy are usually covered by AMCs to expand the market and diverse investors’ portfolio. Sector funds can be a great addition; they follow a focused strategy towards investments. These funds capitalize on the growth and performance of the specific sector by investing predominantly in companies operating within that sector.  

Sector funds can also potentially offer high returns when timed wisely. For example, during the pandemic, the pharmaceutical sector and its companies saw prosperity, which resulted in high demand for these companies and increased returns for their investors. Sector funds employ a tactical approach to investing and allocate funds so that the investors can seize the market trends and global political shifts.  

Sectoral funds are more effective for long-term investors. Investors who are hoping to invest for long-term goals like child’s education expenses or college should consider this type of investment fund. This is because sectoral funds are high risk funds because they lack diversification within the sector, they require careful market timing so that the investor can determine when to enter and exit the fund, and they can be volatile to changing economic and socio-political sphere. Hence, investors saving for long-term goals and planning to stay invested for the long haul can consider this type of fund to add to their portfolios! 

What are Sector Funds?

Sector funds are equity mutual funds that invest in companies belonging to a specific sector. Investors get targeted exposure to a specific sector of the economy like healthcare, energy, IT, infrastructure, real estate and many more.  

For a sector fund to qualify as one, fund managers need to invest 80% of the fund’s total assets in equity and equity-related instruments of a particular sector. Sectoral funds invest in companies of all sizes from large-cap to mid-cap to small-cap. For example, a sector fund with focus strategy on energy sector would invest in companies such as Reliance Industry, NTPC, ONGC, Adani Green Energy, Tata Power and more. Similarly, a sector fund focused on apparel and accessories would focus on companies that thrive in this sector such as Titan, PC Jeweller, Kaylan Jeweller, Campus and more!   

Characteristics of Sector Funds:

Here are some characteristics of a sector fund to help you determine if it’s a good investment for your goals: 

• Targeted exposure: Sector funds offer investors concentrated exposure to a specific industry or sector, allowing them to capitalize on the growth potential of that sector. 

• Higher volatility: They are focused on a single sector like energy or healthcare, sector funds can be more volatile than traditional mutual funds. The performance of the fund can be heavily influenced by the performance of the underlying sector. 

• Potential for higher returns: If the chosen sector performs well, sector funds can generate higher returns than traditional diversified funds. However, if the sector underperforms, the fund’s returns may be lower. 

• Sector-specific risks: Sector funds are subject to sector-specific risks, such as regulatory changes, economic downturns, or technological disruptions that can negatively impact the performance of the sector. 

• High risk: Sector funds invest in a specific sector and lack diversification which means these are some of the riskiest funds to consider.  

• Long term investment: A particular sector may take years to thrive so investors who are planning to invest for long-term goals like their child’s education can consider sector funds. An investment horizon of 5-10 years is good for sector funds. 

Who Should Invest in Sector Funds?

Here’s how you determine if sector funds investment is right for you and your goals: 

• Investors with high risk tolerance: Due to their concentrated nature and limited diversification, sector funds can be more volatile. Investors who are comfortable with potential fluctuations in their investments are more likely to benefit from sector funds. 

• Investors who are looking for long-term growth potential of a specific sector: Investors who have a strong conviction in the future prospects of a particular industry or sector can use sector funds to capitalize on that growth. 

• Investors who are prepared to accept potential losses: Sector funds are not immune to downturns, and if the chosen sector underperforms, investors may experience losses. 

• Investors who are seeking targeted exposure: Investors who want to focus their investments on a specific industry or sector, rather than a broad range of assets, can use sector funds to achieve this goal. 

• Investors who are looking for long-term investments: Investors who are looking to stay invested for 5-10 years and more should look at sector funds. Sectoral growth can take time and hence, staying invested is key to seeking potential growth.  

However, sector funds may not be suitable for investors who: 

•  Are risk-averse: If you are uncomfortable with the potential volatility of sector funds, it may be better to invest in more diversified options. 

• Lack knowledge about the sector: Investing in sector funds without a thorough understanding of the underlying industry can increase the risk of making poor investment decisions. 

• Are seeking short-term gains: Sector funds are typically more suitable for long-term investments, as the performance of a sector can fluctuate significantly over shorter periods. 

Sector Funds vs Traditional Mutual Funds

Benefits of Investing in Sector Funds for your Child’s Education

Sector funds can also potentially offer high returns when timed wisely. Here are some reasons why adding them to your long-term investment portfolio can be beneficial.  

• Time horizon: Sector funds are well-suited for long-term investments, aligning with the goal of saving for education. If you are saving for college, you are probably planning to stay invested for 8-10 years which can be a good time horizon for sector funds.  

• Industry-specific focus: Sector funds concentrate on specific industries or sectors, allowing you to capitalize on the growth potential of a particular field. 

• Potential for outperforming the market: Sector funds can potentially outperform broader market indices if the chosen sector experiences strong growth. These funds can potentially beat the rising education inflation and help you send your child off to college debt-free. 

• Potential for higher returns: If the chosen sector performs well, sector funds can generate higher returns than traditional diversified funds. However, if the sector underperforms, the fund’s returns may be lower. 

How to Invest in Sector Funds?

If you are looking to invest in sector funds, you can use the EduFund App to get started. Here’s a stepwise guide: 

• Download the EduFund App and create an investment account by completing your KYC process. 

• Explore the variety of sector funds that align with educational goals. 

• Consider factors like the fund’s expense ratio, minimum investment amount, and lock-in period. 

• Select the sector fund that best suits your child’s future educational needs and risk tolerance. 

• Place an SIP or lumpsum order for the selected fund and start investing for your child’s education.  

Risks of Investing in Sector Funds

Sector funds carry high risk! Sector funds are heavily invested in a specific industry or sector, making them more susceptible to fluctuations in that particular area. If the sector experiences a downturn, the fund’s performance can decline significantly.  

Before investing in a sector fund, it is essential to conduct thorough research and due diligence to understand the fund’s investment strategy, portfolio holdings, and performance history. You can also consult a financial advisor to help you understand whether it’s the right fund for you and how much you should invest.  

This is all about sector funds. If you wish to invest in sector funds for your child’s education or for any other long-term financial goals, then consult a financial advisor before starting. You can connect with our experts on the EduFund app before starting an investment goal for your child’s education.