2026 Best Sectoral Mutual Funds || All about Sectoral Mutual Funds

When a Sector Is “Booming”, What Does It Really Mean for Your Money?

Every market cycle throws up a familiar narrative.
Consumption is back.
Infrastructure is booming.
Manufacturing is India’s next big story.

You hear these phrases everywhere on business channels, social media threads, etc. The conclusion seems obvious: “This sector is overweight. I should invest here.”

But here’s the real question most investors never get a clear answer to:

How do you actually invest in a booming sector  in a structured, disciplined way without turning it into a risky bet?

This is where sectoral mutual funds come into the picture.

In this newsletter, we take a structured, investor-first look at sectoral funds: what they are, how they work, where they fit (and don’t fit) in a portfolio, and how to think about them without getting carried away by short-term excitement.

The goal is simple: to help you understand sector investing clearly — so you can participate in opportunities without compromising long-term discipline.

What Are Sectoral Mutual Funds?

Sectoral mutual funds are equity mutual funds that invest exclusively in a single sector or industry.

As per SEBI regulations, sectoral funds must invest at least 80% of their assets in equity instruments belonging to a specific sector. This makes them fundamentally different from diversified equity funds.

For example:

• A technology fund invests only in IT services and software companies

• A banking fund invests only in banks, NBFCs, and financial institutions

The objective is straightforward: capture outsized returns when a sector is in a strong growth phase. When conditions turn favourable, sectoral funds can significantly outperform broader market indices — but this comes with higher risk.

Different types of Sectoral Mutual Funds?

Some of the commonly available sectoral funds include:

Banking & Financial Services Funds
Invest in banks, NBFCs, and insurance companies. Performance depends on credit growth, interest rates, and asset quality.

Information Technology Funds
Focus on IT services and software companies. Returns are influenced by global tech spending and currency movements.

Pharmaceutical & Healthcare Funds
Invest in pharma companies, hospitals, and diagnostics. Often considered relatively defensive.

Infrastructure Funds
Exposure to roads, railways, power, construction, and capital goods. Highly linked to government capex and execution.

PSU Funds
Invest in government-owned companies across banking, energy, and utilities. Strongly influenced by policy reforms.

Energy & Power Funds
Include oil, gas, power utilities, and renewable energy players. Sensitive to demand and regulation.

FMCG & Consumption Funds
Focus on consumer-facing companies benefiting from rising incomes and stable demand.

Metal & Commodity Funds
Highly cyclical, driven by global commodity prices and economic cycles.

Auto & EV Funds
Invest in automobile manufacturers and ancillaries, including EV-linked businesses.

How Sectoral Funds Work?

There are 2 ways in which Sectoral Funds works:-

Active Management Approach - Most sectoral funds follow an active management approach. Fund managers decide which stocks to include and how much weight each should carry based on their outlook and research. The objective is to outperform the sector benchmark through better stock selection.

Passive Management Approach - Some sectoral funds are passively managed. These funds track sector-specific indices such as the NIFTY Bank Index or the BSE Healthcare TRI and aim to replicate their performance rather than beat them.

Although sectoral funds are concentrated, their internal allocation remains dynamic.This internal diversification helps manage risk while maintaining focused sector exposure.

Advantages of Sectoral Mutual Funds

Potential for Superior Returns - Sectoral funds can generate great returns when their chosen sector outperforms the broader market. 

For example: SBI Healthcare Opportunities Fund delivered a 5-year CAGR of 25.24% and a 3-year CAGR of 24.98%, substantially beating the NIFTY 50. 

Targeted Growth Exposure - Investors with strong conviction in specific industries or sectors can align their portfolios directly with their investment thesis.

Easier Performance Tracking - With all holdings within one sector, tracking fund performance and understanding the drivers becomes easy. You can directly correlate returns to sector-specific news, policy changes, and economic data.

Tactical Allocation Opportunities- Experienced investors can employ sectoral funds for tactical allocation based on sector cycles.

2025 Best Sectoral Mutual Funds ?

Data as of 1 jan 2026

Based on our analysis, the best-performing sectors and funds in 2025 were driven by long-term fundamentals rather than short-term trends and are outlined below.( Refer to the chart above)

1. Infrastructure: Long-term leader

Best performer: ICICI Prudential Infrastructure Fund delivered  around 31.4% 5-year CAGR, supported by sustained government capex.

Infrastructure rewarded investors who stayed invested through the cycle, though near-term returns remained volatile due to the sector’s cyclical nature.

2. Healthcare and Pharma: Scale with consistency

Best performers: SBI Healthcare Opportunities and ICICI Prudential P.H.D. delivered mid-to-high 17%-19% CAGR over 3–5 years.

Healthcare balanced growth with defensiveness and recorded some of the highest Sharpe ratios, indicating strong risk-adjusted returns.

3. PSU Funds: Cyclical but rewarding

Best performers: Aditya Birla Sun Life PSU Fund and SBI PSU Fund delivered close to 30% 5-year CAGR.

PSU funds can generate outsized returns but remain highly sensitive to policy continuity and sector cycles.

Top Sectors Likely to Drive Sectoral Fund Performance in 2026

These three to four sectors are likely to play a decisive role in driving sectoral fund performance in 2026.

Banking and Financial Services- Banks are entering 2026 in a strong position, with low bad loans and steady credit growth. The key things to watch will be how well they maintain their margins and how easily they are able to attract deposits.

Infrastructure and Capital Goods-  Government spending continues to drive new orders in sectors like defence, railways, and power. Funds in this space can do well if projects are executed on time and as planned.

Power and Renewable Energy: India’s energy transition is now a scale story. Performance will depend on grid readiness and state-level policies.

Information Technology: 2026 will be shaped by deal quality over quantity, with spending shifting toward AI and cloud migration.

Tax Implications of Sectoral Mutual Fund Investments

Taxation in sectoral funds is the same as the taxation applicable to equity mutual funds in general.

Short-Term Capital Gains (STCG)

Units sold within 12 months attract STCG tax at 20% flat, regardless of your income tax slab. Securities Transaction Tax (STT) of 0.001% also applies on redemptions.

Long-Term Capital Gains (LTCG)

Units held for more than 12 months qualify for preferential tax treatment:

• Gains up to ₹1.25 lakh per financial year: Tax-free

• Gains exceeding ₹1.25 lakh: 12.5% flat tax (no indexation benefit)

Risks Associated with Sectoral Funds

Sector-specific downturns
If a particular sector faces problems due to economic slowdown, policy changes, or new technology, the entire sector can suffer. When you invest in a sectoral fund, your investment is fully exposed to these risks.

High concentration risk
Sectoral funds invest in just one sector, which means there is very little diversification. If that sector performs poorly, your entire investment is affected, with no support from other sectors to balance the losses.

Strong dependence on timing
Returns from sectoral funds depend heavily on when you enter and exit. Investing after a sector has already run up can lead to lower returns, while exiting too early during short-term volatility may cause you to miss long-term gains.

Higher volatility and deeper ups and downs
Sectoral funds are generally more volatile than diversified equity funds. Their price movements can be sharper, leading to bigger ups and downs in your portfolio compared to diversified funds.

Best Investment Strategy for Sectoral Funds

1. Core-Satellite Approach- Maintain 70-80% in diversified equity funds (core) and 20-30% in 1-2 high-conviction sectoral funds (satellites). This balances growth potential with downside protection.

2. Sector Cycle Rotation- For sophisticated investors, rotate between sectoral funds based on economic cycles. Buy defensive sectors (healthcare, consumer staples) during slowdowns; shift to cyclical sectors (infrastructure, auto) during expansions.

3. SIP Strategy- Systematic Investment Plans in sectoral funds helps to average out entry prices and reduce timing risk. This smooths volatility over the long term.

4. Tactical Opportunities- When a fundamentally strong sector has fallen sharply, say by 20% or more, you can consider investing gradually through SIPs over the next 12 to 18 months. The idea is to build exposure during the recovery phase and exit as the sector reaches the next peak in its cycle.

Conclusion

Sectoral mutual funds can offer great opportunities for informed investors who are willing to accept higher risk in pursuit of potentially higher returns.

However, sectoral investing requires strong conviction, a clear understanding of the sector, and emotional discipline. These funds work best as satellite allocations alongside diversified equity funds, not as a replacement for them.

If this feels overwhelming, you can book a free call with our SEBI-regulated experts, who can guide you and support you throughout your investment journey.

Disclaimer:
This content is for educational purposes only and does not constitute investment advice. Please consult a qualified financial advisor before making any investment decisions.