Sectoral Funds
Sectoral funds are equity mutual funds that must invest at least 80% of their assets in companies from a single sector, such as banking, pharma or technology, making them concentrated and higher-risk.
What Are Sectoral Funds?
A sectoral fund is an equity mutual fund that invests most of its money in companies belonging to one sector of the economy. Under SEBI's categorisation rules, a sectoral equity fund must invest at least 80% of its total assets in equity and equity-related instruments of a particular sector. Common examples of sectors are banking and financial services, pharmaceuticals and healthcare, information technology, FMCG and automobiles.
These funds exist for investors who believe a particular industry will do better than the overall market over a period of time. Because the money is concentrated in one industry, sectoral funds can deliver sharp gains when that sector does well, and sharp losses when it does not.
You will usually find them listed separately from diversified equity funds on fund platforms, with the sector named in the scheme name (for example, "… Banking & Financial Services Fund").
How Do Sectoral Funds Work?
- The AMC chooses a sector from the list of sectors published by AMFI in consultation with SEBI. AMFI updates this list every six months, and new sectoral funds must be launched only within it.
- The fund invests at least 80% in stocks of that sector. The remaining portion (the "residual portion") can go into other equity, money market instruments and other permitted assets within regulatory limits.
- The fund is benchmarked against a sector index, so its performance is judged against that sector rather than the broad market.
- Overlap is monitored. Under SEBI's circular dated 26 February 2026, a sectoral or thematic fund's portfolio may not overlap more than 50% with the AMC's other equity schemes (other sectoral/thematic schemes and other equity categories), except large-cap schemes. Overlap is computed quarterly as the average of daily overlap values.
- Existing schemes get time to comply. Sectoral and thematic schemes that existed on the circular date have three years to meet the overlap limit, with a suggested glide path of reducing the excess overlap by 35% in year one, a further 35% in year two and the remaining 30% in year three. Schemes that still fail must be merged with other schemes.
How portfolio overlap is measured
SEBI's method compares two schemes stock by stock. For each stock held by both, take the lower of the two weights; overlap is the sum of these minimum weights.
Practical Example
Example 1: The effect of concentration
Neha has a ₹10,00,000 portfolio. She puts ₹3,00,000 into a banking sector fund and keeps ₹7,00,000 in diversified equity funds.
- Suppose banking stocks fall 25% in a year while her diversified funds are flat.
- Loss on the sector fund = 25% × ₹3,00,000 = ₹75,000.
- Portfolio value = ₹10,00,000 − ₹75,000 = ₹9,25,000, a fall of 7.5% on the whole portfolio from one sector.
- If she had held only ₹1,00,000 (10%) in the sector fund, the loss would have been ₹25,000, or 2.5% of the portfolio.
Example 2: Calculating overlap between two schemes
| Stock | Weight in Sector Fund A | Weight in Flexi-cap Fund B | Lower of the two |
|---|---|---|---|
| Bank P | 18% | 6% | 6% |
| Bank Q | 15% | 5% | 5% |
| NBFC R | 10% | 3% | 3% |
| Others not common | 57% | 86% | 0% |
| Overlap | 14% |
Overlap = 6% + 5% + 3% = 14%, well within the 50% limit.
Why Are Sectoral Funds Important?
- Risk: Concentration means higher volatility than diversified funds. One regulatory change or downturn can hit every stock in the portfolio.
- Timing matters: Sectors move in cycles. Entry and exit points affect returns far more than in a diversified fund.
- Portfolio construction: A sector fund can add a deliberate tilt, but it can also duplicate exposure you already have; for example, many large-cap and flexi-cap funds already hold big weights in banks.
- Tax: Sectoral equity funds are taxed as equity-oriented funds, provided they meet the tax definition of investing at least 65% in domestic listed equity. As per rules applicable from 23 July 2024, short-term gains (units held up to 12 months) are taxed at 20%, and long-term gains at 12.5% above ₹1.25 lakh a year.
Key Features of Sectoral Funds
| Feature | Details |
|---|---|
| Minimum sector exposure | 80% of total assets in equity of one sector |
| Sector list | As published and updated half-yearly by AMFI in consultation with SEBI |
| Overlap limit | Not more than 50% with other equity schemes of the AMC (large-cap schemes excluded) |
| Benchmark | Usually a sector index |
| Risk level | Typically "Very High" on the riskometer |
| Suitable horizon | Long, with tolerance for deep drawdowns |
| Debt version | SEBI also permits sectoral debt funds (80% in AA+ and above rated debt of one sector, for sectors such as financial services, energy, infrastructure, housing and real estate). This article covers equity sectoral funds. |
Benefits and Limitations
Benefits
- Lets you take a focused view on an industry through a professionally managed, diversified basket of that sector's stocks.
- Can complement a core portfolio when used in small amounts.
- The 50% overlap rule makes sectoral funds more distinct from an AMC's other equity funds.
Limitations and risks
- Very high concentration risk; no other sectors to cushion a fall.
- Long periods of underperformance are possible when a sector is out of favour.
- Requires monitoring of the sector's cycle and valuations.
- Past outperformance of a "hot" sector often attracts investors late in the cycle.
Comparison With Related Concepts
| Concept | Meaning | Key difference | Practical implication |
|---|---|---|---|
| Sectoral fund | At least 80% in one sector | Narrowest equity category | Highest concentration risk |
| Thematic fund | At least 80% in a theme, which may combine two or more sectors | Broader than one sector | Still concentrated, slightly more spread |
| Flexi-cap fund | At least 65% in equity across market caps | Diversified across sectors | Suitable as a core holding |
| Index fund on a sector index | Tracks a sector index passively | No active stock selection | Lower cost, but same sector risk |
How Do Sectoral Funds Apply to Mutual Fund Investors?
- Scheme selection: Read the Scheme Information Document (SID) to see exactly how the sector is defined and which benchmark is used.
- Portfolio sizing: Many investors limit total sector/thematic exposure to a small share of their equity allocation; decide your own limit based on risk appetite.
- Check overlap: Compare the sector fund's top holdings with your existing funds. AMCs must now publish category-wise portfolio overlap levels monthly on their websites.
- SIP vs lump sum: A SIP can reduce timing risk, but it does not remove sector risk.
- Monitoring: Review the fund against its sector benchmark, not against a broad index alone.
Common Mistakes and Misconceptions
- "Last year's top sector will stay on top." Correct view: sector leadership rotates. Why it matters: buying after a big rally can mean entering near a peak.
- "A sector fund diversifies my portfolio." Correct view: it diversifies only within one industry. Why it matters: if your diversified funds already hold that sector heavily, you are increasing, not reducing, concentration.
- "A sectoral fund and a thematic fund are the same." Correct view: SEBI now treats them as separate categories; a theme can span several sectors. Why it matters: the risk profile and diversification differ.
- "Sector funds suit beginners who want high returns." Correct view: they suit investors who understand the sector and can tolerate large swings. Why it matters: panic selling after a sector crash locks in losses.
Important Terms to Know
- Thematic Funds: Equity funds investing in a theme that can cover several sectors.
- Diversification: Spreading money across assets to reduce risk.
- Volatility: How sharply an investment's value moves up and down.
- Benchmark Index: The index a fund's performance is compared with.
- Market Risk: The risk of losses due to overall market movements.
- Riskometer: SEBI's risk-level indicator for schemes.
- Portfolio Rebalancing: Bringing your allocation back to target.
Key Takeaways
- Sectoral funds put at least 80% of assets into one sector, making them concentrated and highly volatile.
- SEBI's February 2026 rules separate sectoral and thematic funds and cap overlap with an AMC's other equity schemes at 50% (large-cap excluded).
- They can add a deliberate tilt, but they are not a substitute for a diversified core portfolio.
- Check overlap with your existing funds and size the position based on your risk appetite.
Related Glossary Terms
- Thematic Funds
- Equity Mutual Funds
- Flexi-Cap Funds
- Diversification
- Volatility
- Benchmark Index
- Risk Appetite
References
- SEBI circular: Categorization and Rationalization of Mutual Fund Schemes (26 February 2026)
- SEBI circular text (PDF), including Annexure A overlap methodology
- Income Tax Department: Section 198, Income-tax Act, 2025
Educational Disclaimer
This article is published by FynnChintan Finserv, an AMFI-registered mutual fund distributor, for educational and informational purposes only. It is not personalised investment, tax or legal advice, and it does not recommend any specific scheme. Mutual fund investments are subject to market risks; read all scheme-related documents carefully. Regulations and tax rules change from time to time, so please check the latest SEBI and Income Tax rules, and consider your financial goals, risk profile and the scheme documents (or consult a qualified tax adviser) before making a decision.
To build a balanced core before adding sector bets, explore our guides on Diversification and Asset Allocation.
Frequently Asked Questions
Are sectoral funds riskier than diversified funds?
Generally yes. All the main holdings depend on the same industry's fortunes, so a sector-specific problem, such as a regulatory change or a demand slowdown, can affect almost the whole portfolio. Diversified funds spread risk across many sectors, so a fall in one is often balanced by others.
How are sectoral funds taxed?
Equity sectoral funds that invest at least 65% in domestic listed equity are taxed as equity-oriented funds. As per rules applicable from 23 July 2024, gains on units held up to 12 months are taxed at 20%, and gains on units held longer are taxed at 12.5% on total equity long-term gains above ₹1.25 lakh a year.
What is the minimum sector exposure in a sectoral fund?
A sectoral equity fund must invest at least 80% of its total assets in equity and equity-related instruments of the sector it is named after. The remaining portion can be held in other permitted assets, such as other equity or money market instruments, within SEBI limits and as stated in the scheme document.
How much of my portfolio should be in sectoral funds?
There is no regulatory limit for investors. It depends on your goals, horizon and comfort with volatility. Many investors treat sector funds as a small "satellite" holding around a diversified core. Consider your total exposure to the sector, including what your other funds already hold.
What is SEBI's 50% overlap rule for sectoral funds?
From SEBI's circular of 26 February 2026, a sectoral or thematic fund must not have more than 50% portfolio overlap with the same AMC's other equity schemes, except large-cap schemes. Overlap is measured quarterly using daily averages. Existing schemes have three years to comply, failing which they must be merged.
Can I do a SIP in a sectoral fund?
Yes. A SIP spreads your purchases over time and can soften the impact of buying at a single high point. However, it does not change the fact that the fund depends on one sector, so a SIP should still fit within your overall allocation plan.
This explanation is for general education only and is not investment advice. Mutual fund investments are subject to market risks; read all scheme-related documents carefully.