Best Sector Funds - India's Top Performing Sector Mutual Funds to Invest in 2022

Updated on: Mar 17th, 2023


5 min read

Debt mutual funds predominantly invest in fixed-income instruments such as treasury bills, corporate bonds, government securities, and other debt and money market instruments.

Introduction to Sector Funds

Sector or sectoral funds are a kind of equity funds that concentrate their portfolio towards equities of companies across all market capitalisations of a particular sector. These funds are capable of providing benchmark-beating returns at times when the markets are favourable, and the sector is expected to grow.

Since these funds concentrate their portfolio towards a particular sector, they naturally possess a higher risk of concentration. The losses resulting from these funds can be magnified when a bearish trend grips the markets, and the underlying sector is not performing as expected.

Who Should Invest in Sector Funds?

Sector funds are suitable for aggressive investors or those willing to take higher levels of risk in exchange for the potential to earn overwhelming returns. The risk of concentration of these funds is on the higher side since these funds invest in equities of a particular sector.

It is essential to stay invested for at least five years to mitigate market volatility. Investors must understand how the companies of the sector they are choosing to invest, go about their business. If not, it is not advisable to invest in these funds. You may consider allocating about 10% of your portfolio towards sector funds.

Taxability of Sector Funds

As per the Budget 2020 amendments, dividends offered by all classes of mutual funds are added to the overall income of the investors and taxed as per their income tax slab. This way of taxing dividends is referred to as the classical way of taxation. Before the Budget 2020, dividends were made tax-free in the hands of investors as the fund houses paid dividend distribution tax (DDT).

As sector funds are a class of equity funds, the capital gains offered by these funds are taxed like that of any other equity fund. Short-term capital gains (realised on selling equity fund units within a holding period of one year) are taxed at a flat rate of 15% with applicable cess, irrespective of your income tax slab.

Long-term capital gains (realised on selling equity fund units after a holding period of one year or more) of up to Rs 1 lakh per year are made tax-free. Any gains above the prescribed limit attract a tax of 10%, and there is no benefit of indexation provided.

Risk Possessed by Sector Funds

Since sector funds are a class of equity mutual funds, they essentially carry the following risks:

a) Risk of Concentration Since these funds invest heavily in equities of a specific sector, they carry a high risk of concentration. Some experts categorise sector funds under the riskiest class of mutual funds. You need to remember that high-risk investments come with high return potential. b. Volatility Risk The market fluctuations have a direct influence on these funds. If the sector is performing well, then the fund may provide excellent returns. On the other hand, if the sector fares poorly, the losses may be magnified. c. Liquidity Risk Liquidity risk is the probability of the fund manager being in a position wherein he fails to sell the underlying securities at a loss.

Advantages of Sector Funds

Investing in sector funds comes with the following advantages:

  • You get the potential to earn inflation-beating returns.
  • You get the benefit of exposure towards a diversified portfolio constituted by equities of companies across all market capitalisations of a particular sector.
  • Sector funds are an excellent investment option for long-term financial requirements.

Things You Should Consider Before Investing in Sector Funds

You have to be aware of and ensure the following before you invest in a sector fund:

  • Sector funds carry higher levels of risk, and you must be willing to assume this risk.
  • You have to ensure that your investment objectives are in line with the objectives of the fund.
  • Don’t allocate more than 15% of your portfolio towards these funds as they carry a higher level of concentration risk.
  • Sector funds may require you to carefully analyse and assess the market conditions before investing in a sector fund.
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