How To Find The Best Sector Mutual Funds In 2022?

Introduction

 

Mutual funds are an investment vehicle for the pooling of funds in exchange for the issuance of units, wherein the funds are invested in securities for investors with similar investment objectives.

 

When you wish to invest your money, it is of the utmost importance that you receive proportionate returns. Therefore, when searching for mutual funds to invest in, it is essential to select the highest-rated ones.

 

The investment market is full of legal jargon and complexities, particularly when it comes to mutual funds. It is difficult to comprehend the subtleties if you do not fully comprehend what you are getting into. Among these are sector mutual funds.

 

 

 

What Are Sector Mutual Funds?

 

SEBI mandates that sector mutual funds invest at least 80 percent of their assets in a specific sector. They concentrate on a specific industry, such as banking, technology, healthcare, real estate, energy, etc. A banking fund, for instance, invests exclusively in banking stocks. Sector mutual funds give investors the opportunity to participate in sectors with strong growth potential.

 

These mutual funds offer significant returns, but only if the timing of the investment is exact. The timing of sector-specific fund investments is crucial. Additionally, the withdrawal from the fund becomes important, because sectors follow the business cycle.

 

The fund is affected by the cycle’s ups and downs. Investing in high-growth industries has the potential to yield large profits. However, a decline in the industry might also result in large losses. This is primarily due to the lack of diversity in the case of sector mutual funds.

 

Each asset in a sector fund is invested in a single industry. Consequently, the fund’s volatility tends to be significant in case the concerned sector gets impacted. Sector funds are an option for portfolio enhancement. However, one must have sufficient patience to endure market cycles.

 

Should You Invest In Sector Mutual Funds?

 

Despite market volatility, retail investors are betting on the sector and thematic funds. According to data from the Association of Mutual Funds in India, these funds reported the greatest fresh inflows of the nine categories of pure equity mutual fund schemes in April, totalling Rs 3,843 crore. 

 

Compared to diversified equity funds, sectoral funds bet on the performance of a specific sector, hence they are inherently riskier. These funds can experience several cycles of ups and downs since they are cyclical.

 

In the past, a few industries have consistently performed well, while the same sectors were negatively impacted when the circumstances changed. One must be aware of the risk factors and the potential returns since investing is all about taking on extra risk to increase returns. Given that most themes go through cycles, sectoral fund returns may be greater in the short term. On the other hand, historically, these funds don’t perform consistently over a longer time frame.

 

The key to investing in sector mutual fund is having a thorough understanding of the sectors and their future possibilities. Historically, many investors invested in sectoral funds based solely on their past returns, which is not the optimal strategy.

 

Investors have been evaluating the one to three-year performance of top sectoral mutual funds such as infrastructure and technology, which have generated returns between 10 and 28 percent (please see table at the end). As the economic recovery gains momentum, certain sectors, including infrastructure and basic materials, are likely to perform well. However, investors must be wary of the uncertainties caused by geopolitical conflict, spiralling inflation, and rising interest rates.

 

Factors To Consider Before Investing In Sector Mutual Funds

 

• Investment Goal

 

Determine your investment objectives, i.e., whether you seek growth or value. If you want to maximize your investment in sectoral funds, you should have at least a 3-5-year investment horizon. The explanation is straightforward. For any industry to reach its height, a considerable amount of time is required. When investing in these funds, you should have long-term objectives such as retirement, supporting a child’s school, health, etc.

 

• Risk Appetite

 

Before investing, one of the most important elements to consider is your risk tolerance, which involves determining whether you prefer to play it safe or take some chances and whether you have a high-risk tolerance or a moderate risk appetite.

 

Depending on your risk tolerance, and your ability to tolerate market volatility, you can select appropriate funds for investment. Risks and returns are directly proportional, therefore you must decide if you want to invest in mutual funds aggressively or conservatively.

 

Sector mutual fund are concentrated investments, hence they do not provide portfolio diversification to the same degree as diversified equity funds. The lower your portfolio’s diversification, the greater its risk. Unlike other equity funds that invest in companies across many sectors, Sectoral funds can only invest within the limitations of a single sector and cannot simultaneously take advantage of investing in other sectors to offset risks.

 

Therefore, if the entire industry is experiencing difficulties, there is no other investment in the portfolio that can safeguard you. Consequently, even though the return potential appears to be great, the risks are still exceptionally significant. Therefore, investors should create a financial plan to assess their risk tolerance before selecting a fund category.

 

• Expense Ratio

 

You must be crystal clear on the expenses that eat into your profits. To manage the sectoral fund in which you intend to invest, asset management companies will charge you a fee known as an expense ratio. This fee essentially covers administrative and operating expenditures, such as the fund manager’s pay. The fee is assessed on an annual basis.

 

• Market Timing

 

Although it is a well-known adage that market timing is impossible, when it comes to sector funds, though, timing is crucial. These results are dependent on the economic cycle. A thorough examination of the industry would aid in determining the stage. For instance, stocks in the banking sector stocks perform well when it is anticipated that interest rates will decline, and vice versa. For these funds to provide favourable returns, a considerable study is necessary. In addition, market timing applies to both the entry and departure of an investment.

 

• Historical Return

Do not completely rely on just the performance of the sector in the past, as past returns do not guarantee future returns. Rather, discover the opportunities that would contribute to the expansion of the sector and invest in them.

 

• Diversification

Having a diverse portfolio is generally advisable before investing in sector funds. It would reduce the danger of exposure to a single sector. Typically, the investor’s portfolio should only contain these funds to the extent of 15% of their total assets.

 

• Taxation

 

The post-tax returns are what count. You should be knowledgeable about the taxation of sectoral money to determine that. Depending on how long you held the investment, you may or may not have to pay taxes on the capital gains you made after selling your sectoral fund.

 

• Short Term Capital Gain Tax (STCG): If you sell your investments within a year, the profits are considered short-term capital gains (STCG), and you must pay a 15 percent tax on them.

 

• Long-Term Capital Gain Tax (LTCG): The gains from any sectoral fund held for longer than a year are regarded as Long Term Capital Gains and are subject to taxation (LTCG). Gains up to one lakh in a fiscal year are exempt from taxation. Gains over one lakh rupees are subject to a 10% tax.

 

Important Aspects Of Sector Mutual Funds

 

• Time Period

 

Typically, the investment horizon for sector funds ranges from medium to long term. Fund managers do not prefer to make short-term investments in sector funds. The extended length affords the industry sufficient time to develop and realize its full potential.

 

• Focus On Specific Sectors

 

Sectoral Funds concentrate on a single market segment, allowing no possibility for diversification and relying solely on the success of that sector.

 

• High Expense Ratio

 

Typically, sector-specific funds come with a premium price tag for management costs since they are very often active funds.

 

• Risk

 

Due to their reliance on a single industry and lack of diversification, sector funds are frequently seen as riskier mutual funds.

 

• Inflation Hedge

A sector fund can also outperform inflation if the sector’s performance is inversely proportional to that of the economy. For example, the pharma sector boomed during the covid-19 pandemic.

 

• High Return

 

It is possible to earn significant returns by investing in sector funds if a specific industry is expected to grow over time.

 

Who Are These Funds Best- Suited For?

 

As stated previously, these funds invest in a single industry or sector, and their lack of diversification makes them one of the riskiest mutual funds available. Therefore, only investors who are comfortable with high-risk investments should consider investing in them.

 

Active and Informed Investors: If you are a novice investor, you should not invest in sector funds. Entry and exit timing are difficult, even for seasoned investors, when investing in sector funds. It requires extensive research on the industry. Active investors who stay updated on the latest news and headlines can more accurately predict which industry will do well. Even investors who are professionally entwined with the sector will have access to knowledge that will help them make the most of their sectoral fund investments.

 

Investors Aiming for Tactical Allocation: Some industries, such as the automobile industry, are considered cyclical. Consequently, investors with a high-risk tolerance who are willing to gain exposure to businesses at the bottom of their cycle might profit substantially by investing in sectoral funds. A wise investor can invest in a sector that is at the trough of its cycle and wait. patiently until it reaches its peak. As soon as it reaches its height, they can sell it for a profit. Consequently, investing in sectoral funds involves some skill and perseverance.

 

Major Advantages

 

The primary purpose of sector funds is to provide market exposure to investors whose portfolios lack exposure to a particular area. Sector equity funds are intended to provide diversification where it is lacking. Therefore, if an investor believes that a particular sector is about to experience a period of consistent and strong growth, he or she may consider investing in sector equity mutual funds to capitalize on the growth, especially if the fund wasn’t present in his portfolio before.

 

This is why technology-related funds are typically preferred. Innovations can generate enormous rewards for technological companies, and investors may profit from this expansion.

 

Major Disadvantages

 

The downsides of investing in a sector-focused mutual fund exist for the exact same reason as the advantages: putting all of your eggs in one basket exposes you to the danger of losing everything if something goes wrong. The lack of diversification, which is a characteristic of sector-focused funds, means that you are overexposed to a particular sector, to the associated risk and volatility.

 

Since sector funds are more specialized and have fewer economies of scale, they may also be a bit more expensive.

 

Types Of Sector Mutual Funds

 

1. Natural Resource Sector: These funds invest in timber and forestry, in addition to oil and gas, and other energy sources. Typically, these funds are suited for long-term growth investors.
2. Real Estate Sector: These funds allow smaller investors to share in the profits from the real estate industry without having to purchase a property. They frequently generate both growth and money. 
3. Financial Sector: These funds make financial sector investments. Securities from investing, insurance, banking, mortgage, and accounting organizations will be among the holdings.
4. Utility Sector: This fund makes investments in businesses that offer goods and services connected to phones, energy, and gas.
5. Healthcare Sector: focuses on the healthcare sector and makes equity investments in biomedical companies, hospital conglomerates, pharmaceutical businesses, medical device manufacturers, etc.
6. Technology Sector: These funds aim to increase exposure in the technology industry. Computers, electronics, and other information technology that is employed in a variety of applications are the main emphasis of this industry.

 

Best Sector Mutual Funds (as per 5-year return)

 

Scheme	5-Year Return	AUM(INR)(Cr)
Tata Digital India Fund	28.19%	5,529.21
ICICI Prudential Technology Fund	27.61%	8,629.17
Aditya Birla Sun Life Digital India Fund	26.30%	3.033.30
SBI Technology Opportunities Fund	25.19%	2,396.08
Quant Infrastructure Fund	22.10%	589.64
The Nippon India Pharma Fund	16.18%	4,600.68

Source: AMFI (data as on 20/07/2022)

 

How To Find The Best Sector Mutual Funds?

 

Kuvera is the one-stop solution for finding sector mutual funds for investment purposes. You just have to complete your KYC and open a Demat account on its website or its app on the play store and app store. You are ready to go!

 

FAQs

 

• Which sector mutual fund is best in 2022?

During the covid epidemic, the pharmaceutical and technological sectors performed strongly. When there is a large inflow of national budgets into the infrastructure segment, banking and infrastructure funds do better than average. Sector funds are mutual funds with high returns and high risk. Although these funds may be very volatile in the short term, they have the potential to deliver greater returns over the medium to long term.

 

Please find the top-performing sector mutual funds in the above-mentioned table.

 

• Which mutual fund is best for the future?

There is no certain answer to this as mutual funds are subject to market risk. The key to wealth generation in the long term is a diversified portfolio. However, you can analyze the data and information, and consult your financial advisor as per your financial objective. 

 

• Which sector mutual fund is best now?

As per the above-mentioned table, Tata Digital Funds has outperformed every sector mutual fund in the past 5 years. However, it is important to note that historical returns are not a guarantee for future returns.

 

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