New NFOs drive record inflows in sectoral mutual funds: Should you invest?

Retail investor interest in Indian mutual funds continues to surge, with a significant portion of new investments flowing into thematic and sectoral funds.  Data released by the Association of Mutual Funds in India (AMFI) for June 2024 reveals that these categories attracted over half (50%) of the total inflows into equity-oriented schemes, amounting to Rs 22,351 crore. 

The rise of thematic and sectoral funds reflects a growing investor desire for targeted investment opportunities. But what's the difference between these two categories?

Sectoral Funds: These funds focus on companies within a single industry or sector, such as information technology (IT), pharmaceuticals, or banking. For example, a "Banking Sector Fund" would invest primarily in companies like HDFC Bank, ICICI Bank, and Axis Bank.

 

Thematic Funds:  These funds invest in companies across different sectors but are united by a common theme.  The theme could be anything from infrastructure development to electric vehicles (EVs) or consumption. An "Infrastructure Fund" might invest in companies building roads, bridges, and power plants, while an "Electric Vehicles Thematic Fund" could invest in car manufacturers like Tata Motors and Maruti Suzuki, battery makers like Exide Industries, and charging infrastructure providers like Fortum Charge & Drive India.

New Fund Offerings fuel investor interest:

The launch of 17 new open-ended mutual funds in June 2024 played a pivotal role in driving inflows.  These NFOs collectively garnered Rs 15,227 crore, highlighting investor interest in new investment opportunities. Notably, nine of these NFOs belonged to the thematic and sectoral category, raising a total of Rs 12,974 crore. These funds focused on specific themes like manufacturing (Baroda BNP Paribas Manufacturing Fund, Mahindra Manulife Manufacturing Fund, SBI Automotive Opportunities Fund), financial services (Helios Financial Services Fund), and special opportunities (Kotak Special Opportunities Fund, SAMCO Special Opportunities Fund, WhiteOak Capital Special Opportunities Fund). This trend underscores the growing demand for targeted investment options beyond traditional broad-market funds.

"Inflows in equity funds have continued to record inflows for 40th months and have been highest in this period as investors remained steady post-election results. All categories witnessed inflows barring ELSS funds and focused funds segments. The inflows in equity mutual funds were mainly led by sectoral/thematic funds which accounted for over 55% of the monthly inflows due to an increase in the number of NFO schemes. Around 17 open-ended NFOs were floated in June, which together mobilised Rs.0.15 lakh crore with the highest contribution by sectoral/thematic funds of Rs.0.13 lakh crore. Around 9 sectoral funds were launched in June 2024”," said Sanjay Agarwal, Senior Director, CareEdge Ratings.

Investors are increasingly seeking to diversify their portfolios beyond traditional asset classes. "People are taking concentrated bets on specific themes... This is a good diversification strategy, provided the investment horizon is aligned with the chosen theme (typically 3-5 years). "Thematic and sectoral funds offer investors the opportunity to capitalize on promising sectors like defense, consumption, and manufacturing, which are expected to benefit from upcoming policy changes and budgetary announcements," said Sandeep Bagla, CEO of TRUST Mutual Fund.

These categories even contributed around 47% to the total number of folios added in equity mutual funds. Around 19.29 lakh new folios were added in sectoral/thematic mutual fund categories in June. There were around 2.05 crore folios in total as of May in the sectoral/thematic funds category,  which have risen to 2.24 crore a of June 2024.

Anand Vardarajan, Chief Business Officer, Tata Asset Management, explains the mad rush for thematic funds: 

 A bull market typically begins with a "beta rally" characterized by significant index moves. As the bull market progresses, investors increasingly seek new opportunities to generate alpha. This leads to the exploration of emerging themes and sectors where potential for growth exists.

During the later stages of a bull market, investors often focus on industries with the potential for substantial future growth. These themes gain popularity, attracting more attention from investors. The final phase of a bull market is usually marked by individual stocks becoming the most sought-after by investors.

However, the current market conditions in India suggest that investors are still in the early stages of the bull market. 

Strategists advise focusing on broader themes and sectors with strong growth prospects. The positive outlook is supported by India's improved macroeconomic factors, such as terms of trade, flexible inflation targeting, and strong domestic flows. As the bull market progresses, investors should prioritize risk management and be selective in their stock/sector choices.

AMCs capitalize with niche offerings

Asset management companies (AMCs) are actively responding to the growing investor enthusiasm for thematic and sectoral funds by launching a plethora of new offerings. These offerings range from the recently launched "Nifty Tourism Index Fund" by Tata AMC - the first-ever tourism-focused fund in India - to ICICI Prudential's "Oil and Gas ETF" and Mirae Asset's "Nifty EV and New Age Automotive ETF and  Motilal Oswal's Nifty Defence Index Fund.  This trend is projected to continue, with fund houses filing applications for NFOs in niche areas like technology, transportation, and electric vehicles.

While thematic and sectoral funds offer the potential for concentrated returns, investors are advised to carefully consider their investment horizon and risk tolerance before making any investment decisions. It is crucial to choose a scheme that aligns with your financial goals and risk appetite.

"Most investors can do without thematic and sector funds. If you feel excited about a theme or a sector and feel that it is not reasonably represented in your diversified fund, consider investing a small part of your corpus in it," said Value Research in a note. 

Some industry observers suggest a potential advantage for mutual fund companies (AMCs) in launching thematic NFOs. Sebi,  the market regulator, restricts AMCs to having only one scheme per category. However, thematic funds can be seen as a way to navigate around this rule. By creating thematic funds, AMCs can potentially offer multiple investment options within a broader theme, even if they already have a fund in a related traditional category. This allows them to cater to investor interest in specific sectors or trends without technically violating the SEBI rule.