Sectoral mutual funds: Defence, metals gave double-digit returns in 2 years while tech, consumer in red — here’s why

Investors in sectoral mutual funds should look at how different sectors have performed over the past two years, as returns have varied sharply across segments.

Motilal Oswal Financial Services (MOFSL), in its latest India Strategy report, noted that while the market remained range-bound and is below its September 2024 peak, there was significant divergence across sectors.

Here’s what investors need to know about the performance of different sectors and what it means for those investing through sectoral mutual funds.

These are returns of the respective sectors, so the returns of individual sectoral mutual fund schemes can vary depending on their portfolio holdings and allocation. However, the data shows the broader picture for investors.

Defence, metals, and PSU Banks remained the key outperformers, while technology, consumer, media, and real estate were the key laggards over the past two years.

What does this sharp divergence across sectors mean?

Vikas Gupta, CEO & Strategist, Omniscience Capital, said, “This data clearly shows that despite the markets not doing well at headline levels, specific sectors can do well.”

For investors in sectoral mutual funds, this highlights how sector-specific earnings growth and valuation changes can drive returns.

For example, the defence sector returns are a combination of earnings growth and PE re-rating from mid-40s to mid-50s currently. On the other hand, the PSU Banks returns are driven purely by increased earnings despite a slight PE de-rating from 8x to 7.5x.

Metals have had extraordinary earnings growth, with earnings more than doubling over the two years, but the PE de-rated from nearly 30 to around 15, so the net returns are a combination of earnings growth and re-rating or de-rating of PE, he said.

“For most of the others showing negative returns, it is mostly PEs being very high in 2024 and the PE de-rating which has given negative returns. Whatever earnings growth these sectors might have had was cancelled by the PE de-ratings,” Gupta added.

What should mutual fund investors do?

Since sectoral mutual funds invest primarily in stocks belonging to a particular sector, their performance is closely linked to the earnings growth and valuations of that sector.

Gupta suggested that investors should focus on estimating a sector’s fair PE based on its long-term growth expectations and consider allocating to sectors that appear undervalued.

“For most of the sectors, except cyclicals such as metals, earnings growth forecasts are positive,” he said. This means investors can explore sectors that are delivering positive returns, excluding metals.

He cautioned against the IT sector due to the fundamental uncertainty in forecasting future revenues and earnings over the next couple of years.

“Similarly, media remains a concern. On consumption-related sectors, caution is warranted given the still very high PE ratios compared to the expected growth rate of the sector,” Gupta added.

Other than the banking sectoral funds, Gupta said investors should ideally stick to allocating to flexi-cap funds and large-cap funds and let the fund manager decide which sectors to allocate more to.