Sectoral Funds: Features, Benefits, Taxation, & More

Sectoral funds are equity funds that invest in companies in the same sector or industry. The sectors can be banking, pharmaceuticals, information technology, etc.

These funds can potentially deliver benchmark-beating returns in a rising market scenario (bull phase). 

However, the associated risk can be high when the sector is going through ups and downs. 

Let’s understand further who should invest in sectoral funds.

How Do Sectoral Funds Work?

As per SEBI guidelines, these funds must invest at least 80% of total assets in the given sector. For example, an IT sectoral fund will invest the majority of the assets in IT companies.

Fund managers distribute the assets in large-cap, mid-cap, and small-cap companies in the specific sector. These companies are selected upon the fund manager’s strategy, analysis, and the trend in the market.

How are Sectoral Funds Different Than Thematic Funds?

Sectoral funds invest only in a specific sector. Whereas thematic funds invest in a theme that ties various sectors together. 

For example, an infrastructure thematic fund may invest in cement, steel, and construction firms. A sectoral fund sticks to the defined sector. 

Benefits of Investing in Sectoral Funds

1. Exposure to a Specific Sector

Sectoral funds allow investors to tap a specific industry that may perform well in coming years. Instead of investing in individual stocks of the sector, investors can park their money in these funds.

Fund managers take care of the allocation depending on the sector’s performance against the benchmark. 

2. Potential of Superior Returns

Sectoral funds invest in equity instruments of the same industry across market capitalization. There’s a good chance the sector may outperform and deliver superior returns. 

With thorough research and analysis, the underlying assets may beat the benchmark. Therefore, investors can earn superior returns when the sector is performing well.

3. Portfolio Diversification

The only diversification sectoral funds offer is the allocation across market capitalization. 

However, you can introduce diversification to your overall portfolio by introducing a new emerging sector.

You can take advice from your financial advisor to choose the sector that aligns with your portfolio. 

Factors to Consider Before Investing in Sectoral Funds

1. Your Risk Appetite

Sectoral funds can be risky at times. You can earn higher returns if the sector grows. However, if the sector underperforms, all the underlying companies may drop values. 

As the diversification within funds is limited, these funds can be more volatile than other schemes. So you may want to consider your risk appetite before investing in sectoral funds. 

2. Investment Horizon

Equity funds expect you to stay invested for a longer horizon to beat the volatility. A sector also takes time to grow and achieve the desired outcomes.

Therefore, you may have to consider staying invested for a longer duration. Make sure the expected horizon of the sectoral funds is suitable for your portfolio. Otherwise, you can always explore other equity schemes. 

3. The Growth of The Sector

Make an informed decision by researching what’s expected from the sector. Select a sector that truly has the potential to grow in the coming years.

That way, you will be aware of the timeline the funds take to reach the returns you are looking for. 

However, please note that markets can be uncertain. A few ups and downs along the way are inevitable. 

4. Performance of The Fund Manager

Checking the past performance of the sectoral fund would be of no use. The sector is most likely to perform differently in each economic cycle.

Instead, check the performance of the fund managers. How many times have their analysis delivered superior returns over the years?

That’ll give you an idea of the expertise of the fund manager.

5. Expense Ratio

The expense ratio is the small fee that mutual fund houses charge you for managing your assets. As per SEBI, the fee can be between 0.85% to 2.25% of the total assets under management. 

Make sure you read the factsheet of the fund to understand the expense ratio structure for the fund. 

Tax Implications on Sectoral Funds

Sectoral funds follow equity taxation rules based on the investment horizon. 

Investors have to pay a 15% tax on Short-Term Capital Gains (Investments redeemed before 12 months)

Long-Term Capital Gains (investments redeemed after 12 months) above 1 Lakh are taxable at 10%.

Explore new taxation rules across various mutual fund categories. 

Who Should Invest in Sectoral Funds?

Sectoral funds are suitable for investors with high-risk appetites and longer investment horizons to beat volatility. Similar to thematic funds, these funds are not ideal for new investors.

Investors who can handle high volatility without panic-selling funds can go for it. However, it is important to make an informed decision.

Make sure you are aware of the sector’s growth potential and fund manager’s history before investing.

Conclusion

Equity mutual funds offer a wide spectrum of investment options. Sectoral funds are one such avenue that allow investors to explore a growing industry.

Though the risk can be high, the reward can also skyrocket when the sector expands over the years. 

So if you want to distribute some of your assets to a high-risk-rewards scheme, go for sectoral funds.

Advisors at VNN Wealth can help you choose the right funds as per your risk appetite. Get your portfolio reviewed for free. Sketch an investment strategy to fulfill your financial goals. 

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