Sector funds are at the higher end of the risk spectrum, as they invest in individual sectors or themes that either could be the leaders or laggards of the season. This means that at times they do better than the broader market and at others, they lag way behind. For example, over a year, returns from banking funds were at 35.44 per cent, FMCG funds at 33.12 per cent while technology funds were 9.74 per cent. In the diversified category, large-cap funds returned 23.36 per cent and the S&P BSE Sensex earned 25.20 per cent.
If you had invested in technology funds last year, you would have made less money, while an investment in banking funds would have made you more money than the Sensex. So, timing, for both entry and exit, has to be right. Because it's choppy, retail investors have to know what they are getting into. For risk-averse investors a diversified large-cap fund or an equity-oriented balanced fund (which has up to 65 per cent holding in equity) is a better alternative than sector or thematic funds.
But if you want some higher returns and are willing to take the risk, sector funds could sometimes give you that little extra. Returns from these tend to be cyclical, and can even be timed. For instance, with interest rates likely to head down, rate-sensitive sectors such as automobile or banking tend to do well. Hence, it's easier at times for investors to time their entry and exit in these sectors.
Explaining the importance of timing, Surajit Misra, executive vice-president and national head (mutual funds) at Bajaj Capital, says, "Most sector funds tend to attract investors when stocks have peaked. For instance, infrastructure funds collected money when infra stocks were at their peak. So, investors entering banking stocks or banking sector funds now will find it more risky than those who invested in these, say, six months ago."
Similarly, timing your exit is equally important. For sector funds, it is advisable to look at profits and not the holding period. So, set a profit target and exit once you reach that target. Sector funds can also go out of favour, depending on the market circumstances. That is why a sector fund requires far more active monitoring than an equity-oriented balanced fund or a large-cap fund, says Ashish Shanker, head, investment advisory, Motilal Oswal Private Wealth Management.
For those investors who want exposure to a sector but not the risk of under-performance due to the fund manager, Shanker advises investing in passive sector funds in the form of, say, a banking exchange-traded fund. "Such funds will replicate the returns offered by the banking index,'' he says. Another factor to look out for is how long a fund has been in existence and how consistent it is with its mandate. For instance, after the infrastructure boom of 2007-08, many infra funds started moving to other sectors. Similarly, if the corpus of the fund shrinks, or if the sector loses flavour, the fund house might merge it with other schemes. "But since the objective is that it should outperform the index, if the fund moves away from the mandate, it might not meet its objective," Shanker says.
Investors in such funds should ensure that they are invested in the right sector that has an upside. Remember, also due to the risky nature of sector funds, experts suggest limiting your investments to about 5-10 per cent of your portfolio. But the crucial part is to get in or out at the right time.