Sectoral Funds Decoded: Riding the Investment Roller-Coaster

Imagine sitting on a steep roller-coaster ride, coupled with the fear of a crash. That is the world of sectoral funds!

If you do not want to end up stranded in the financial cosmos, read today’s blog, in which we will uncover the secrets of sectoral funds and whether they deserve a place in your investment portfolio.

Overview

Sectoral Funds are a type of equity mutual fund that only invests in companies operating within a specific sector or industry of the economy.

These funds allow the investor to gain concentrated exposure to a particular sector and amplify their returns if that sector outperforms the broader index. However, sectoral funds have increased risks due to a lack of diversification.

These funds focus on various sectors and industries such as technology, healthcare, consumer staples, financial services, energy, and infrastructure.

Benefits

Sectoral funds can offer tempting advantages to investors. Let us have a look at the benefits of sectoral funds:

1. When a chosen sector experiences a boom, sectoral funds can outperform diversified funds. Imagine the tech boom of the late 90s; any technology-focused fund would have given incredible returns to investors.
2. Investing in such a fund offers the investor an opportunity to gain exposure to the sector without analysing each stock within the industry. 
3. Sectoral funds can be used for tactical portfolio diversification, allowing you to capitalise on short-term trends and sector rotation.

Risks

1. Sectoral funds come with a high probability of losses. If the chosen sector underperforms, sectoral funds will suffer as fund managers will not have room for diversification and protecting the capital. 
2. These funds are inherently more volatile than diversified funds. Therefore, sharp swings in prices/NAVs are more likely to occur.
3. Understanding the sector dynamics and prospects is essential and complex at the same time before investing. Failure to interpret the sector’s trajectory during the investment horizon could lead to significant losses in the short term. 
4. In the race to earn benchmark-beating returns, choosing the right sectoral fund, after considering the political, economic, and technological landscape, is highly crucial because making the wrong choice might lead to inadequate returns or even losses in the short and medium term.

Performance

The Covid-19 pandemic sent shockwaves throughout the global economy, and many sectors were impacted differently. Sectoral funds felt the heat too.

The Sunny Side

Pharma Funds – As the pandemic raged, demand for healthcare products soared and pharma funds were riding the wave since they delivered consistent returns.

Technology Funds – With the world shifting online, technology companies thrived. Tech-focused funds witnessed exponential growth because of increased dependence on remote work, communication and entertainment platforms.

The Dark Side

If you invested in these sectoral funds, you must have witnessed their consolidation in the past couple of years.

Technology Funds – The initial sector boom, fuelled by the growth of online platforms and digital transformation, faded away when the economies reopened, and offline activities resumed.

Compared to their respective benchmark, some top-performing sectoral funds that doubled their returns during the Covid-19 pandemic were not even at par post-Covid.

As of 23rd February 2024, the broader Nifty 50 index has risen over 91% since November 2020, while the Nifty IT index has risen 82%.

Pharma Funds – Something similar happened with pharma stocks. During the height of the pandemic, these stocks surged due to increased demand for vaccines, diagnostics, and other medical equipment, eventually leading to better pharma funds’ performance. The demand for medical products flattened once the initial panic subsided and vaccine rollouts progressed. This led to a massive correction in the stock prices of the pharma sector.

As of 23 February 2024, the broader Nifty 50 index has risen 91% since November 2020, while Nifty Pharma has only given 64% returns.

Returns Comparison

The table below shows the performance of different sectoral funds in the past 4 years relative to their benchmark.

Technology Sector

Pharma Sector

Example

Let us understand the cycle of sectoral funds with the help of the table.

Suppose investor A invested in technology and pharma funds during Covid 19. Some of the top-performing funds gave massive returns and significantly outperformed their respective benchmark indices, affirming the beliefs of the investor. The table shows that S&P BSE IT TRI & S&P BSE Healthcare TRI gave a return of 58.45% and 21.54% respectively in the year 2021. 

However, investor A stayed invested in these funds with the hope of getting more profits. But after the COVID wave subsided, the market witnessed a stark contrast in the performance of both the technology and pharma sector funds, and these funds gave returns of -22.7% & -11.5%, respectively. Thus leading to catastrophic losses.

This example indicates that sectoral funds concentrate their investments in specific sectors. This concentration leads to their performance moving in tandem with the cyclical nature of the underlying sector. Therefore, the exposure of unsystematic (diversifiable) risk increases substantially.  

*(The funds mentioned above are for educational purposes only and are not recommendations).

Conclusion

After analysing the pros and cons and the recent performance of sectoral funds, the million-dollar question remains: Should you invest? As with most investment decisions, the answer is not a simple ‘yes’ or ‘no’. It depends on your risk tolerance and investment goals. Consider sectoral funds if you are a long-term investor, have a high-risk tolerance, and have a firm conviction in a particular sector. Avoid sectoral funds if you are a short-term and risk-averse investor lacking sector expertise.

Ultimately, the decision is yours. Sectoral funds can be a powerful tool to maximise wealth, but they also need a deep understanding of the sector-specific risks.

Frequently Asked Questions (FAQs)

1. Why should I invest in sectoral funds?

Ans. Sectoral funds offer investors the potential for higher returns (with increased risk). Thus making them a lucrative investment vehicle for those who can take the risk. 

2.  Are sectoral funds right for me?

Ans. The answer depends on your risk tolerance, investment goals, and knowledge of the chosen sector.

3.  Is there a magic formula for picking the right sectoral fund?

Ans. No, there is no guaranteed recipe for success. So, one should evaluate all factors before investing.

4.  Can I time the market with sectoral funds?

Ans. Predicting market trends can be tricky. Therefore, performing self analysis is of utmost importance. 

5.  Can sectoral funds help me get rich quickly?

Ans. Sectoral funds do carry the potential to offer high returns but simultaneously come with amplified risks and volatility. Do not invest in these funds with a get-rich-quick objective!

Disclaimer: The securities, funds, and strategies mentioned in this blog are purely for informational purposes and are not recommendations.