Mutual Funds

Sectoral vs Index Funds

Should you chase sector-specific growth or stick to broad market safety? Explore sectoral funds vs index fund to decide which aligns with your investment goals.

Team Dhan

25 Aug 2025 — 3 min read

Photo by Mathieu Stern / Unsplas

When it comes to mutual funds, investors are often faced with a choice: play it safe with broad market exposure or bet big on a single sector’s growth. Both approaches have their appeal, but they also come with very different levels of risk and reward. That’s why it’s important to know how each type of fund works before deciding where your money should go.

Sectoral funds focus on a single industry with high return potential but higher risk, suitable for active investors with sector knowledge. Index funds offer broad market exposure, lower costs, and steady returns, making them ideal for beginners and passive investors. The article outlines key differences and when to choose each option.

What are Sectoral Funds?

Sectoral funds invest in companies from a single industry or sector. For example, a pharma sector fund invests in pharmaceutical and healthcare companies. Similarly, an IT fund targets companies like Infosys and TCS. These funds can deliver high returns when the chosen sector performs well, but they also carry higher risk due to limited diversification.

Key Features:

High Growth Potential: The sectoral fund will perform very well if the sector performs well.
Higher Risk: Sectoral funds are riskier than diversified mutual funds because they invest in a single sector.

Need for Sector Knowledge: Achieving strong investment outcomes requires a clear understanding of sector-specific trends and the unique characteristics that drive each industry.

What are Index Funds?

Index funds replicate the performance of a market benchmark such as the Nifty 50 or Sensex. These funds invest in the same companies and proportions as the index. They offer broad market exposure, low costs, and suit long-term passive investors. Since they track an index, returns are consistent with overall market performance.

Key Features:

Broad Market Exposure: Index funds invest in several industries, limiting reliance on one sector.
Lower Risk: Diversification across many companies reduces the overall risk, unlike sectoral funds focusing on a single industry.
Cost-Effective Passive Investing: Index funds follow a passive strategy, so they usually have lower fees and expenses than actively managed funds.

Key differences

Here’s a clear comparison between sector funds and index funds to help you understand their key differences:

Feature	Sectoral Funds	Index Funds
Focus	Target industries like banking or pharma for investment, looking for growth opportunities.	Exposes investors to a collection of sectors by monitoring a wide index.
Risk	There is a high risk of having most funds in a single sector, so any downturn in that sector affects the entire portfolio.	Decreased danger due to including different industries, which stabilises gains and losses.
Returns Potential	It often performs strongly if the chosen sector succeeds, but it is also more volatile.	Returns money that is stable and tied to the market’s movement.
Management Style	It is managed by professionals who often review information and select the best stock options from that group.	A passively managed ETF merely replicates the index choices and changes that sector companies rarely make.
Expense Ratio	As a result, the cost to the investor is usually higher, as managers are working as hard as possible to conduct the analysis and make an effective decision about the catering sector companies.	Some ETFs' management fees are usually lower, as the fund simply copies the index without needing to trade as much.
Investor Skill Needed	You need to know what is happening in the market and recognise the right time to benefit from it.	Suitable for those who want to invest and then keep their funds with little effort.

When Sectoral Funds make sense?

Here are a few situations where investing in sectoral mutual funds may be a suitable choice:

You have in-depth knowledge of a specific sector: If you are an active follower of sectors like IT, banking or pharma, you can have some confidence directing your dollars.
You expect one sector to outperform others: Based on current market conditions or major events, you anticipate that a specific industry will likely outperform others.
You’re aiming for higher returns through focused exposure: If you can handle some risk, some sector funds can do better than broad-based funds if your sector forecast matches reality.

When Index Funds are a better option?

Index funds are designed for investors who value simplicity, low costs, and broad market exposure. Here’s when they may be a smart fit:

You prefer simplicity and consistency over time: Index funds offer beginners broad market exposure without spending significant time or effort researching individual investment options.
You’re new to investing and want easy market access: Since they represent the entire market, index funds are well-suited for new investors with limited time or investment knowledge.
You prefer lower costs and steady returns: Index funds usually have lower fees, which help you keep more of your returns and benefit from the overall returns of the market.

Aligning funds with your goals

The right choice between sectoral and index funds depends on your risk tolerance and investment approach. If you're an active investor with a good understanding of specific sectors and are comfortable with higher risk, sectoral funds may offer the potential for higher returns. On the other hand, if you prefer stability and consistent long-term growth with minimal fluctuations, index funds are likely a better fit. Clarity about your financial goals and overall investing strategy will ultimately guide your decision.