Should you invest in sectoral funds?

Tue, 3 Apr Pre-Open

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Heightened volatility in broader markets and outperformance by certain pockets/sectors has attracted considerable amount of interest into sectoral mutual funds. Considering that these funds invest in specific sectors they tend to beat the broader market if one is invested into the right fund at the right time. However, since these are dedicated funds the returns tend to be highly volatile. So, should investors really take exposure to such funds?

Well, in order to answer that question first we need to understand the pros and cons of investing into these funds. Let us first take a look at the primary motive/advantage for investing into sectoral funds. Sectoral funds offer higher returns if investment is made at the trough of the sector cycle. Now we know that predicting the sector peak & trough is comparatively easier task than predicting market peak and trough. Thus, sectoral funds provide an opportunity to generate better returns through active fund management. Secondly, investing into defensive funds like healthcare and FMCG during volatile times provides stability to the overall portfolio. Further, these funds also provide an opportunity to take exposure to certain sectors that are long term value drivers of the economy. Infrastructure and banking funds are a few examples to that.

However, apart from these benefits an investor must also keep the following points in mind before taking exposure to sectoral funds. The primary motive of any fund is to generate alpha which is the excess return over the benchmark. And there is no historical evidence that sectoral funds have outperformed the benchmark indices on a consistent basis. Again selection of sectoral funds becomes an additional headache for many investors. Further, sectoral funds do not offer any diversification benefit to the investors. The volatility in sectoral funds is also high and thus the risk of losing capital.

Thus, while the sectoral funds offer a play on certain pockets of the market and also an opportunity to generate higher returns they are subject to greater risk. Hence, investors must be careful while making investments into such funds. Selection of a wrong fund at a wrong time can backfire. For instance, someone who had invested into an infra fund a year back might have been losing a considerable amount of money now.

Thus, considering all these factors we believe that an investor should allocate only a small percentage of his portfolio to sectoral funds.