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Should you invest in Sector Funds?

Essentially, they are equity-funds which invest their entire portfolio in stocks of a particular sector. For instance, pharma funds invest only in stocks of the pharmaceutical industry. While they may have a diversified equity portfolio, they are riskier than a plain-vanilla equity fund that diversifies investments across sectors.

Essentially, they are equity-funds which invest their entire portfolio in stocks of a particular sector. For instance, pharmaceuticals funds invest only in stocks of the pharmaceutical industry. While they may have a diversified equity portfolio, they are riskier than a plain-vanilla equity fund that diversifies investments across sectors.When recently a friend of mine recommended a banking fund, I was reminded of the heady days of ‘99. Stock prices of technology companies were soaring then, and it seemed as though there was only way for all these stocks to go – Up. I put a large chunk of my savings into a newly launched technology fund then, in my quest to earn supernormal returns. 

A year later the internet bubble burst. It took almost a decade to recover my capital. I had learned a lesson – the hard way. NEVER TO GET GREEDY. 

But somehow, from time to time, the lure of higher returns has been fuelling retail interest in sector funds. While banking funds are the talk of the town these days, earlier it was infrastructure, pharmaceuticals, and technology funds. 

What are these sector funds? 

Essentially, they are equity-funds which invest their entire portfolio in stocks of a particular sector. For instance, pharma funds invest only in stocks of the pharmaceutical industry. While they may have a diversified equity portfolio, they are riskier than a plain-vanilla equity fund that diversifies investments across sectors. 

Those considering such funds need to keep the following in mind

1. There is a time for each sector

Sector fund performance can be quite time dependent. A look at the return table (See below) will show that pharma sector had a rollicking time (2010-2015) with a long period of outperformance vis-à-vis that of S&P BSE 500. All the returns shaded in green indicate outperformance vis-à-vis BSE 500 index. However, the last four years were a disappointment – when the S&P BSE Healthcare failed to post a positive return. 

All returns in %. Years in green denote outperformance vis-à-vis, S&P BSE 500

FMCG also had their good times (2010-2013) but ever since it has lagged the broader market index. Since 2016, banking funds have been giving market-beating returns. Technology funds have now joined the bandwagon. 

Businesses of some sectors – banking, automobiles or real estate – are closely to the performance of the economy and cyclical. In contrast, sectors like pharmaceuticals or FMCG are stable as long as consumer spending is strong. 

While you have the potential to earn higher return from sector funds, it also entails higher risk. Such funds are for those who can stomach a sharp drop in portfolio value and years of underperformance. Moreover, sector funds can’t be part of your core investment portfolio. 

2. High returns come with higher risk

While you have the potential to earn higher return from sector funds, it also entails higher risk. Such funds are for those who can stomach a sharp drop in portfolio value and years of underperformance. Moreover, sector funds can’t be part of your core investment portfolio. 

3. Informed Calls

Investors in such funds also need to be ahead of the market in identifying potential in sectors. If your next-door neighbour is waxing eloquent about the sector prospects, perhaps you are catching the bull by its tail.

Some experts say, buy sector funds or stocks when it’s beaten down and sell when it gets its place in the sun. That’s easier said than done. 

Investing in these funds is seldom a part-time job. You need to constantly keep your ears to the ground – by keeping abreast of news in the sector, any policy changes, market conditions as well as macro-economic conditions. 

Takeaway

In short, a sector fund is not necessarily the pot of gold at the end of the rainbow. There are high chances of getting your investment calls wrong, despite your best efforts. Retail investors can benefit from a sector’s prospects even by investing in a normal diversified equity fund. So, staying away might be the better option in this case.  

Check the comparison between stocks and mutual funds


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