Sector funds are mutual funds that invest in companies of the same sector for eg. a Banking and Financial Services Fund will invest in banks, insurance companies, NBFCs, Home Finance, Asset Management Companies etc.

Some examples of Sector funds are – Canara Robeco Infrastructure Fund, Aditya Birla Sun Life Infrastructure Fund, Reliance Banking Fund, UTI Banking Sector Fund

Sector funds tend to be cyclical funds. Sector funds tend to be cyclical as most of the sectors tend to follow a cycle and as such sector funds are high risk funds.

In a market cycle if a particular sector is doing badly; the performance of the fund will suffer. Hence, investments in these funds have to be timed well. One could out-perform the market if the call to invest in these funds plays out and on the flipside, an investor could end up severely underperforming when it does not play out. The fund manager of such a fund does not have the freedom to move away from the sector even when it is doing poorly, due to limitations per the mandate and is forced to stay invested in the sector.

To understand sector funds better, let us consider Infrastructure funds. Let’s compare Infrastructure fund’s performance to the performance of diversified equity funds and market index since 2006.

Above is a comparison of the Canara Robeco Infra Fund, Aditya Birla Sun Life Infra Fund, HDFC Equity Fund and SENSEX.

The above chart shows the Infrastructure funds outperforming the diversified equity fund and the SENSEX from 2006-2008 but since then, it’s performance has been below the equity fund and in some years below the SENSEX as well.

Similarly, let’s compare Banking sector funds to diversified equity funds and the market index.

Above chart shows that the Banking sector has consistently outperformed the market as well as the diversified equity funds. Between UTI Banking Sector and Reliance Banking Fund, the Reliance Banking fund has been far superior in terms of performance.

The above examples show that the Banking sector has been in a high growth cycle and has consistently outperformed equity funds whereas infrastructure sector had its peak performance

Dos and don’ts while investing in a sector fund:

Dos

1. Understand the economic conditions for the sector before investing
2. Timing the investment in this fund is important due to cyclical nature. Investor should have a defined entry and exit time frame while investing.
3. Lump sum investment would be better than SIP, due to the tactical nature of the investment.

Don’ts 

1. Do not over allocate capital to such a fund as diversification is low in a sector fund
2. Past returns are not an accurate guide to invest in these funds. Important to look at the mandate of the fund.
3. Do not invest in these funds if investor does not have the risk appetite for this kind of an investment.

It is advisable to consult your independent financial advisor to seek the best course of action.