Do the returns justify the risks of investing in sector mutual funds?

© Nishant Kumar Do the returns justify the risks of investing in sector mutual funds?

What a comeback it has been for the stock markets this year so far. From the lows of March, the leading market indices have not only regained the lost ground but are also hovering around all-time-highs. Even mutual fund investors are finding the NAVs (net asset values) of their schemes on a better footing than before. Many winners, however, have been riding on the back of spectacular performances from two sectors – pharmaceutical and Information Technology.

While the COVID-19 pandemic brought pharma stocks into focus, the restrictions imposed on movements made work-from-home companies and their digital play, investors’ favourites. As a mutual fund investor, there are sector funds focused on pharmaceutical and Information Technology that one can choose to invest in. Over the last 12 months, the returns from these schemes have been 55 per cent and 44 per cent respectively. But, what are these sector funds and how risky are they compared to other diversified funds?

Also read: AMFI data |Thematic mutual funds generate investor interest

Understanding the risks

Sector mutual funds invest only in the stocks of a specific sector or industry. For instance, an information technology (IT) fund would invest only in IT stocks and an infrastructure fund will invest only in infrastructure stocks. This implies that the returns will depend primarily on the fortunes of the sector and hence the risk in them is high compared to diversified large-cap or mid-cap funds.

Although not diversified across industries, sector funds are diversified across market-capitalization. The portfolio of a sector fund comprises large, mid or even small-cap stocks. However, remember, sector mutual funds are the riskiest funds as their fortunes hinge on the performance of the specific sector. Any change in regulations or rules impacting that sector may bring a steeper fall or gain than the broader market.

For a mutual fund investor, it is important to have a core portfolio comprising large-cap schemes with addition of mid-caps for the kicker in returns. However, one needs to be careful while adding sector funds, as the performance may reverse in quick time. Apart from Pharma and IT sectors, not all industries are showing strength as banking, infrastructure mutual fund schemes are still in red over the last 12 months.

Also read: Mirae Asset Banking & Financial Services NFO: Should you invest?

The role of a sector fund is to enhance the return potential of a portfolio in line with its high-risk nature. In investments, there is always a trade-off between risk and return. Investing in a scheme that carries high risk of losing a portion of capital may also have the potential to generate high returns.

Based on one’s risk appetite, one may or may not take some exposure in sector funds. Go for these only if you have a view on a particular sector and are confident of the sector’s future performance. Their fortunes may reverse quickly and hence tracking their performance is important. Once invested, it will also be important to keep a close look at the sector developments and keep reviewing the fund performance on a regular basis. Finally, make sure you have not allocated a higher amount to sector funds and your portfolio is on track to achieving your long term goals.