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Do You Really Need A Sector Fund? – Consider These Characteristics Before Investing

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What are Sector Funds?

Sector Funds are mutual Funds that invest most of its proceeds (corpus) in a particular sector: Information Technology, Pharmaceuticals, Baking etc. They are unlike other mutual funds which are usually invest in a variety of stocks from different sectors.

They are usually overvalued
  
 

They are usually overvalued

One thing to keep in mind would be that most sector funds are launched when the sectors are hot. Additionally, the funds attract new investors after they have probably performed well in the past. Hence it is easily possible that you might find yourself invested in a sector that is overvalued and might not be worth investing in.

They come with high costs and a high redemption fee
  

They come with high costs and a high redemption fee

Most sector funds attract a high expense ratio (fee paid by the investor for having their being manage by a professional team of money managers). Fund companies charge you more for managing them with the farce that they require a lot more specialized research than a diversified equity fund. Additionally, they don't enjoy economies of scale and are therefore unable to keep their costs low.

High redemption fee is usually for the benefit of the investors, as it paid back to the fund not the fund company. It is to avoid investors that chase hot funds temporarily and leave when the returns go cold. Quick entry and exit affects the funds returns negatively.

And don’t really add much (specially diversification) to the portfolio
  
 

And don’t really add much (specially diversification) to the portfolio

‘When you start to invest, make sure you're very broadly diversified. Make sure you keep costs out of the equation.' - John Bogle

All of which, as we have established, a sector fund is not.

You have your diversified mutual funds. Which diversifies away any kind of risk that comes with exposure to a particular sector.

Keep you sector play small. You can go your whole life without it. Be prepared for disastrous results. Chose any sector fund. Look for the fund's worse performance and imagine yourself invested. You should be able to stick through the rough times and not want to divest. There have been times

Imagine having invested in a consumption sector fund mainly geared towards automobiles.

Do you really need it? I would still expose a small portion of my investment portfolio to them.

Maybe just 5-8% of my portfolio.

Some investors can actually use sector funds for diversification. As contradictory as it sounds this might be applicable in some rare cases. Imagine you have a portfolio of 3 different equity diversified funds but when you dig deeper you notice more than 20% of your portfolio is invested in ICICI Bank Ltd. A sector fund geared more towards technology might actually help the investor diversify.

Mainly to use as a tool for speculation
  

Mainly to use as a tool for speculation

You have to admit, it is tempting. To gain exposure to a sector you believe is going to explode or has been lagging. Imagine you are expecting a real estate turn around much before the rest of the industry is anticipating. Or that you understand that the banking system had it rough and was to start reporting a lot of bad debt.

If you still want to invest a larger chunk of your portfolio keep in mind
  

If you still want to invest a larger chunk of your portfolio keep in mind

In the end its all upto you. If you are still not convinced and want to invest a larger chunk of your portfolio keep in mind:

· Avoid the SIP route: SIP is a great idea when you assume that the markets are going to rise over the long term. It helps you average out your cost of investments. A sector fund doesn't always perform well even when the markets are performing well. When it comes to sector funds it's all about the timing which an SIP method of investment doesn't help capture.

· Not suited for long term investors: You are betting on a particular sector. It's all about speculation. Different industries go through different business cycles of growth. You exposed to the cycles of a particular industry and are not diversified enough to stay invested for the long term game.

· Understand the risks and stay updated: The risk that sector funds carry is akin to the risk of the sector they are invested in. If it's an Infrastructure fund be wary of its cyclical nature. When it comes to IT, keep a watch on the actions undertaken by the Trump Administration. They will affect the visa rules for the IT employees of the company.

GoodReturns.in

Story first published: Saturday, July 13, 2019, 9:00 [IST]
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