First of all, what is a Sectoral Fund?
A Sectoral Fund is a Mutual Fund that restricts its investments in stocks of a particular sector. For example: Reliance Pharma Fund invests only in stocks of Pharma companies. UTI Banking Sector Fund invests only in Banks.
An extension of a Sectoral Fund is a Thematic Fund that invests in stocks based on a particular theme. For example: Birla Sun life GenNext Fund invests in companies that are expected to benefit from the rising consumption patterns in India, which in turn is getting fueled by high disposable incomes of the young generation (Generation Next).
Sectoral and Thematic Funds are generally referred to as a single category. Some of the Sectoral funds available in India include Banking, Pharma, IT, Technology, Infrastructure, FMCG etc.
The reason Mutual Funds launch such schemes is that they believe a particular sector will outperform the broader index and generate higher returns.
Risk/Return Profile of Sectoral Funds
Sectoral Funds fall in the 'High risk' 'High return' category of funds. If the particular sector does well, then one can expect higher than market returns. The same is true vice versa.
For example: Franklin Infotech Fund invests in stocks of only IT companies. On April 30, 2011 the fund had an exposure of over 50% of the fund portfolio to Infosys Technologies and over 25% to TCS. When the March '11 Quarter results of Infosys did not meet market expectations, its stock price fell and the value of this fund also fell be over 8% in just two days!
Sectoral Fund: The Pawn or the Queen?
Should you invest in Sectoral Funds?
Sector Funds add a flavour to your portfolio and hold the possibility of increasing the returns of your overall portfolio if they do well. Some of the best performing funds in the last five years have been Sectoral Funds in the Banking and Pharma space.
You should take exposure to Sectoral Funds only if you have the higher risk appetite. Again, you must ensure that investments in Sectoral Funds do not exceed 10% of your total portfolio.
Points to be kept in mind before investing in such funds
Firstly, you need to understand the objective of the Mutual Fund scheme properly. For example: Some Sectoral Funds invests only up to 65% of the portfolio in the stated sector. This can dilute your exposure to a sector.
What is included in the definition of a sector/theme also varies from fund to fund. For example: As on date, DSP T.I.G.E.R Fund and ICICI Infrastructure Fund have significant exposure ICICI bank. The logic being, as infrastructure grows, banks are going to be directly benefited by increased lending. This also needs to be studied.
Secondly, you need to check the exposure of your investment portfolio to a particular sector. For example: Most diversified equity funds already have a good exposure to the banking sector. One must take this into account before taking additional exposure to the banking sector through sectoral funds to avoid over exposure.
Thirdly, you must understand that the fund manager of a sectoral fund is restricted in his investment options and will have to continue to invest in a particular sector even if that sector is not doing well. A diversified fund manager has no such restriction and can easily make a switch.
Lastly, compared to a diversified Equity Fund, a Sectoral Fund is not held in the portfolio for a very long time, say 10-15 years. When a Sector is expected to do well, one buys such a fund and exits the fund once it starts going out of favour. The tenure for such funds generally is 3-5 years. Some amount of timing is required to enter and exit such funds.
For example: The Infrastructure sector in India did very well till the markets crashed in 2008. Even though the markets recovered from the crash, the sector has grossly underperformed the broad index till date.
In conclusion, take an informed decision before investing in a Sectoral/Thematic fund.