In this article, we try to highlight the fact that small-cap funds might be risky yet have a comparatively lower risk than sector funds.

You might have heard many times, long-term investment is a good idea – which is why many people invest for longer period of time in mutual funds with higher risk.

Sector mutual funds are easily one of the riskiest mutual funds in the market. So is long-term investing an ideal way to invest in sector funds?

Long-Term Investment in Sector Funds

We can consider Reliance Pharma fund for the sector fund and Reliance small-cap fund for the small-cap fund.

Here is a small summary of these mutual funds:

Reliance Pharma fund Reliance small cap fund
Rating: 5 stars Rating: 3 stars

Top Holdings include

Divis Laboratories Ltd.
Abbott India Ltd.
Sanofi India Ltd
Cipla Ltd.

Top Holdings include

CBLO(CCIL) – Money market
Navin Fluorine International Ltd. – Equity
Deepak Nitrite Ltd. – Equity
Zydus Wellness Ltd. – consumer goods

Min SIP amount: Rupees 100 Min SIP amount: Rupees 500

Investors who add sector funds to their portfolios should also be aware that timing specific sectors of the market can be riskier and more difficult than trying to time the market as a whole.

As mentioned previously, subsector funds are even more volatile by nature than broader-based funds, as their narrower focus will render them even more vulnerable to the economic cycles that can affect a specific industry, such as banking or mortgages.

Perhaps most importantly, sector fund investors should be prepared to stay invested for at least 5-10 years, so that they can experience the entire cyclical rise and fall of the sector.

Coming back to our analysis

We had considered Reliance Pharma fund as an example of our sector fund and reliance small-cap fund as an example of a small-cap fund.

The graphs below show the variation of NAV(net asset value)over a period of 5 years.

The returns of both the funds are shown below

1-year returns 3-year returns 5-year returns

Reliance Pharma Fund

13.9% 3.4% 15.5%
Reliance Small cap Fund 13.4% 22.7% 35.7%

From the graph, it can be inferred that the net asset value of the Reliance Small Cap Fund does not increase rapidly during the period of 2013 to 2015, but when the markets tend to perform well after 2015 then the NAV of the Reliance Small Cap fund also started increasing steadily.

On the contrary, when we analyze the Reliance Pharma fund, we observe that it does not have a rapid growth from 2013 to 2015.

Another important observation is that when the markets are performing well during the years 2015 and 2017, this fund still does not perform well. This is one of the main disadvantages of the sector funds. If a specific sector is affected then the NAV of the mutual funds pertaining to that sector decreases and takes a long time to recover.

Hence, we can infer that the small-cap funds provide a wider range of diversified funds when compared to sector funds and are less susceptible to risks experienced in a certain sector.

Therefore small-cap funds might be risky but are comparatively less risky than sector funds.

What is a Sector fund?

A sector fund is a fund that invests solely in businesses that operate in a particular industry or sector of the economy. Sector funds are commonly structured as mutual funds or exchange-traded funds (ETFs).

As the name implies, a sector fund is a mutual fund that invests in a specific sector of the economy, such as energy or utilities.

Sector funds come in many different flavors and can vary substantially in market capitalization, investment objective (i.e. growth and/or income) and class of securities within the portfolio.

Sector funds do not fall into a particular category such as large-cap value or mid-cap growth. Instead, they are divided into the following categories.

Natural Resources Funds: These funds invest in oil and gas and other energy sources, as well as timber and forestry.
Utility Funds: These funds invest in securities of utility companies. They are usually designed to pay steady dividends to conservative fixed-income investors
Real Estate Funds: These funds provide a way for smaller investors to participate in the gains from real estate
Financial Funds: These funds invest in the financial industry. Holdings will include securities of investment, insurance, banking, mortgage and accounting firms.
Health Care Funds: These funds can cover any kind of for-profit medical institution, such as pharmaceutical companies
Technology Funds: These funds seek to provide exposure in the tech sector. This sector focuses primarily on computers, electronics and other information technology that is used in a wide range of applications.
Precious Metals Funds: These funds provide exposure to a variety of metals, such as gold, silver, platinum, palladium, and copper.

Sector funds are designed to provide market participation for investors whose portfolios lack exposure in a given sector. The main reason that an investor would want to consider a sector fund is the same as for a particular individual stock: The investor feels that the sector is about to experience a period of strong growth.

What is a small cap fund?

The “cap” in smallcap stocks refers to a company’s capitalization as determined by the total market value of its publicly traded shares. Smallcap stocks are generally defined as the stock of publicly traded companies that have a market capitalization ranging less than ₹500 crores. They invest in companies from all kinds of sectors and not just a limited number of industries.

Small-cap mutual funds are generally risky but when coupled with an SIP investment scheme appreciable results may be achieved.

Happy investing 🙂

Disclaimer: the views expressed here are of the author and do not reflect those of Groww.