Sectoral funds: How to meaningfully benefit from investing in sectors? Here’s what experts advise

On the face of it, a sectoral fund may appear to be an attractive option to invest into a particular sector, with all of the potential of that particular sector with none of the headaches associated with cherry-picking of the individual stocks. It seems like a perfect option, correct?

But, in fact, experts advise that investors must carefully scrutinise such thematic or sectoral funds before investing; and even then be prepared for some possible shocks.

“Sectoral funds are for more seasoned investors who can patiently ride out cycles which sometimes run contrarian to the broader market trend, and also get into undervalued sectors ahead of time, which means investing against popular opinion,” says Mayank Bhatnagar, Chief Operating Officer, FinEdge.

“If a particular sector has witnessed a significant upswing, one will need to understand the near to medium term prospects of the sector before considering further allocations,” says Girish Lathkar, Partner and Co-founder, Upwisery Private Wealth.

A thorough research and understanding the stages of growth of the sector against the backdrop of the overall cycle is important.

An investor has the choice to keep investing across cycles or alternatively an investor can consider playing contrarian by moving to sectors which are depressed but have better prospects in the medium term and wait out.

An understanding of the nuances of the sectoral funds spectrum will give us an idea of how they work.

Sectoral funds do reflect the underlying potential of the theme as they must invest 80% in the respective sector. This also brings in both the upside potential and downside risk that sectors go through.

Experts advise to limit the exposure to 5% to 10% of the overall diversified equity portfolio; thus first build a diversified portfolio and then follow the sectoral allocation limits. This way even if one has missed any specific sector rally, diversified funds allocation will compensate to some extent as they have allocations spread across sectors.

Some sectors like Pharma, Auto and IT are sectors that have long-term growth potential. “However, the problem arises when investors try to speculate in them by trying to time their entry and exit from these sectors,” explains Bhatnagar.

Sectoral funds are not meant as short-term bets, but rather for benefiting from the broader paradigm shifts from events like demographic or economic shifts. “One can invest into these sectors through SIPs with a 5-7 year horizon,” says Bhatnagar.

But here your time frame (read time invested in the market) and behavioural biases, come into play.

Sectoral funds can trigger a unique set of behavioural biases which could end up impacting a retail investor's journey. Looking back at missed sectoral opportunities is like investing with an eye in the rear view mirror, and is not at all advisable, says Bhatnagar.

Sectoral funds may be more volatile that the broader equity markets, and so they may end up testing an investor’s resilience. Thus, many times, investors get impatient and jump ship after staying invested for 2-3 years, only to see the trend reversal take place just after they have exited, say experts.

So what is the way out for the retail investor?

“Ideally, retail investors should avoid sectoral and thematic funds and stick with diversified funds such as flexi caps, multi caps, or small/mid cap focused funds depending on their individual goals,” says Bhatnagar.

Finally, if you must play the sectoral game then here too experts give you the low-down on how to go about it.

“There can be two ways to play Sectoral/Thematic fund,” says Rahul Bhutoria, Director and Founder, Valtrust.

If it is a structural theme – then an SIP will work. For example, banking or financial services. If it is a tactical call – then a lumpsum exit and entry will be a better option.

“If you are taking a tactical call then please look for a fund where there is active management (of the fund),” says Bhutoria.

Due diligence before investing in your sectoral fund

“The choice of a sectoral fund requires investors to be forward looking and strategic,” says Bhatnagar.

So, investing into a banking sector fund after rates have already been slashed will do no good, because the change will already be priced in. One has to have the courage and conviction to buy what others are actively selling!

Sectoral fund investing doesn’t require you to be right all the time, but it does require you to be savvy with financial markets and have a point of view at the very least.

To meaningfully benefit from sector funds, detailed research and understanding is required, say experts.

“As the sector performance determines the return of the individual scheme, it is vital to understand the overall economic cycle and the stage a particular sector is in before allocating to sector funds,” says Lathkar. For example, a rising interest rate scenario would mean stress to banking sector and vice versa, and thereby influence allocations.

SIPs as an alternative

Most retail investors feel that SIPs (Systematic Investment Plans) are a way to beat the market uncertainties. True to an extent, but in sectoral funds research and staying invested are as important as your SIPs.

“Simply starting a SIP is not enough – you need to be able to build enough investing resilience to weather the market ups and downs, especially if you’re investing into a sectoral fund which is bound to be more volatile than the broader market,” says Bhatnagar, who advises putting only a small part of your investing corpus into a particular sectoral fund.

Also, experts suggest that investments are linked to clearly defined goals, and having the support of an investing expert to fall back on when things go south.

“Investors can use SIP as a vehicle to invest in sectors as long as they have very long-term horizon and will keep investing both in upswing and downswing,” says Lathkar.

To be sure some sectors like BFSI and IT tend to be more predictable than some of the others like Infra, Defence, etc.

Manik Kumar Malakar is a personal finance writer.