Should you invest in sector funds?

Sector funds are Mutual Funds that invest pre-dominantly in stocks of companies of a particular sector.

The sector is pre-decided and is a part of the fund's investment mandate. e.g. a fund like Reliance Pharma fund will predominantly invest in companies that are pharmaceutical manufacturers (e.g. Sun Pharma, Cipla) or manage hospitals (e.g. Fortis) etc.

Currently sector funds are mainly available for the following sectors - Pharma, IT, Banking, Infrastructure and FMCG.

The returns of these sector funds are closely tied with the overall performance of that sector.

At Goalwise, we don't recommend investing in sector funds.

We recommend only diversified funds where the decision to identify the best performing companies in the best performing sectors lies with the fund manager.

There are several reasons for not recommending sector funds:

1. Lack of diversification

Investing in a sector fund means tying your returns to the fortunes of that particular sector and not to the overall economy. Any individual sector can undergo several years of under-performance while other sectors flourish. In a diversified portfolio consisting of investments in several sectors, when one sector under-performs, the other sectors can make up for it thus reducing risk.

2. Requires sector timing

A sector fund will keep investing its entire money in that sector even if the outlook for that sector is not promising. Why? Because that's what it is mandated to do. So if you don't want to end up stuck in a bad sector, the onus will be on you to identify those inflection points and move out of that fund.

3. There is a better way of doing it

Leave it to the fund manager of a diversified fund. If there is a particular sector that actually has high potential going forward (based on budget, economic growth etc), there is no reason why the fund manager of a diversified fund wouldn’t be investing heavily in it.

A diversified fund's manager can choose stocks from any sector. What's stopping her from over-weighting stocks from the more promising sectors?

Or in other words, there is no reason to believe that we will be able to identify and time sectors better than a professional fund manager.

Investing is simple. And good investing is as much about avoiding bad/unnecessary investments as it's about making the right ones.