What are Sector Mutual Funds?
According to SEBI guidelines, sectoral mutual funds invest at least 80 percent of their investments in a specific sector or industry. They emphasize on a certain field, such as banking, healthcare, real estate, oil, etc. Sector Mutual funds provide investors with an opportunity to invest in industries with a high potential for success. A sector fund would have some portfolio constraints that enable the portfolio manager to select the fund's investment options that fall within the particular stated purpose of the fund. Sector funds do not provide the benefit of portfolio diversification as the investments are primarily restricted to just that one sector of the economy. For ambitious investors and for those prepared to take more risks, a sector fund could be well suited as a strategic investment.
Types of Sectoral Funds
There are various types of Sector Funds such as -
Healthcare: Healthcare funds include pharmaceutical firms, biotechnology companies, and businesses that make groundbreaking advancements in the field of medicine or medicinal research.
Real estate: This category of fund offers an opportunity for small investors to explore the real estate sector's returns. Investors get an advantage in both income and growth.
Financial: This includes insurance, finance, investment, and accounting firms' securities.
Technology: Investments in the sector fund are mostly made in electronics and other information technology used for different purposes.
Features of Sector Mutual Funds
Emphasis - Sector funds concentrate on a particular sector. They do not, however, offer diversification. The success of the fund ultimately depends on that particular sector.
Investment tenure - Sector funds are for mid and long timeframe. Investments in the short term are highly risky. Also, investments are for a specific timeframe. Since sectors have a cyclic structure. It's sensible to leave the investment once the investment hits a peak. Thus, a thorough market study is needed for this.
Higher Returns - If it is anticipated that a sector will do well over a set period, then returns will be high.
Risks - Since sectoral funds focus on a specific sector and lack diversification, they are also deemed to be more risk-bearing mutual funds. In case the sector underperforms due to structural changes in the economy, the funds could perform poorly.
Hedges - Sector funds may be a nice option for hedging. In other words, in order to hedge an investment portfolio, a sector inversely proportional to the economy will be great.
Who should invest in sector funds?
Every investor has his or her investment priorities. An investment has different attributes, such as time period, amount, returns, risk, etc. Sector funds are ideally suited to people who do not hesitate taking massive risks. Typically, sector funds are for participants who have a clear understanding of the workforce and market dynamics of a certain sector. Investors looking to invest for a tenure of 5-7 years or more can consider this investment. Because of the high-risk aspect associated with these investments, investors who want to invest safely and have limited financial capital are advised to search for alternative opportunities.
Investors who have a well-diversified portfolio, and have a good understanding of the broader economy could invest a small portion of their assets in sector funds as a strategic bet to generate a higher alpha.
How to select the right sector fund?
Investors can consider the following parameters while selecting the right sector fund for you -
Comprehensively consider the purpose of the fund. For eg, in the specified sector, few funds spend only 65 percent of the portfolio. As a consequence, this will dilute the visibility of the business and may not produce expected returns.
The flow of the economy is identified by cycles, and at various periods, sectors will exhibit different rates of growth. Thus, when investing in this, it is wise to look into how the market is operating as a whole by looking at the company's background and the market's previous results. This helps to consider patterns, and the investor can assess how the demand reduces or expands occasionally.
Timing the Market:
While it's a common saying that the market can't be timed. Yet pacing plays a significant role when it comes to sector funds. The success of these depends on the economic cycle. Detailed analysis is needed to produce successful returns from these funds. The timing of the market persists for both the investment's entrance and exit.
It is generally recommended to have a diversified portfolio when investing in sectoral funds. It would help to reduce the chance of the portfolio being over-exposed to just one sector. Ideally, these funds can be around 5 percent -15 percent of the portfolio of the investor. However, it is always prudent to work out the right allocation with a financial planner or mutual fund distributor.
Do not focus solely on the sector's past results. Instead, acknowledge and invest in the prospects that will help the sector grow.
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