Should you invest in sectoral mutual funds in 2025? What they are, and the pros and cons explained

Sectoral mutual funds invest in a single industry, such as banking, pharma, technology, infrastructure, or energy. In contrast to diversified equity funds that spread money across a host of sectors, a sectoral fund parks its entire portfolio in one theme. That makes them far more concentrated and hence more volatile, but also well-placed for strong returns if that particular sector does well. These funds became especially popular during phases when certain industries outperformed the broader market, drawing in investors looking for targeted opportunities.

What sectoral funds aim to do

Sectoral funds are built for investors who want to take a view on the long-term prospects of one specific industry. For example, someone who believes India’s manufacturing boom will continue may consider an auto or capital-goods fund. Similarly, investors who expect strong credit growth might choose a banking or financial services fund. Because the fund manager invests only within that particular sector, the portfolio reflects industry cycles very closely. When the sector expands, these funds can outperform diversified funds; when sentiment turns, they fall just as sharply.

Why some investors prefer sectoral funds

One advantage of sectoral funds is the possibility of outsized returns during strong industry cycles. When a sector undergoes a recovery or multi-year expansion, a focused fund tends to benefit more than a broad-based equity fund. They also afford the investor an avenue to express a “theme”-for example, renewable energy, digital transformation, infrastructure spending, or healthcare innovation. Another appeal is one of transparency: because the investment universe is narrow, investors can easily comprehend what they are buying and track the underlying companies.

Risks and limitations you should be aware of

The same concentration that drives higher returns in a good phase also increases risk. If the chosen sector underperforms, the entire portfolio takes a hit because there is no diversification to cushion the fall. Sector cycles are often unpredictable and influenced by factors such as regulation, global demand, commodity prices, and interest-rate movements. Another minus is timing—investors often get into these funds after a sector has already rallied, making it harder to capture meaningful gains. These funds can also be unsuitable for long-term core investing because their performance varies sharply across years.

Where to invest

In general, sectoral funds suit those investors who have a stable, diversified equity base and want to add a small tactical allocation for higher risk–higher return opportunities. They also work better for investors who follow markets closely, understand sector-specific drivers, and are prepared for volatility. Those with low risk tolerance or looking for predictable long-term compounding may be better off sticking to broad-based flexi-cap, large-cap, or multi-cap funds.

How much to invest and for how long

Most financial planners recommend limiting sectoral exposure to a small portion of the equity portfolio and not more than 10-15 percent. Since sector cycles often take time to play out, at least a three-to-five-year holding period smoothes out volatility. It’s also useful to review the sector’s fundamentals periodically instead of holding the fund passively for very long periods.

The bottom line

Sectoral funds can add meaningful returns when an industry is going through a strong growth phase, but they can also heighten losses if the cycle were to turn. These can be useful for investors who understand the sector and treat it as a satellite holding rather than as the core of their portfolio. For most others, broader equity funds could deliver better risk-adjusted returns without the stress of timing the market cycles.