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Sector and thematic funds attracted Rs 46,137 crore in 2023-24, the largest inflow across all fund categories, according to data from the Association of Mutual Funds in India (Amfi). Many of these funds have delivered hefty returns over the past year: PSU (public-sector unit) funds averaged 89.9 per cent, infrastructure funds 63.6 per cent, and pharma-ceutical funds 51.1 per cent.
Drivers of high inflows
These funds are capable of giving higher returns than diversified funds. “When their past returns look attractive, a lot of money flows into them,” says Renu Maheshwari, Sebi-registered investment advisor, co-founder and principal advisor, Finscholarz Wealth Managers.
In the case of diversified equity funds, fund houses can offer only one fund per category. However, for thematic categories, numerous funds can be launched targeting different market segments. The proliferation of new fund offers (NFOs) also helps fund houses garner inflows.
Many investors have been drawn to certain themes and sectors because they believe in their potential. “The government’s goal is to make India a $10 trillion economy by 2030. Currently, production-linked incentive-driven manufacturing and government capex-driven infrastructure are attractive themes,” says Shaily Gang, head-products, Tata Asset Management.
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High and quick returns
The primary advantage of these funds is their potential to deliver high returns quickly. “An investor who can accurately select the right sector/theme and time their entry and exit well can earn disproportionately high returns,” says Vivek Banka, co-founder, GOALTELLER.
Many investors can discern sector trends. “Once they have identified a market segment they believe will perform well, they can invest in it through sector/ thematic funds,” says Gang. Many can select a sector but lack the ability or resources to select individual stocks. “Sector and thematic funds are a good option for them. Investing in these funds also reduces the risk of poor stock selection,” says Maheshwari.
Steep downturns possible
These are highly volatile funds. “The sectors/themes favoured by the market can change without warning. For instance, the power sector was buoyant in 2007 but declined steeply in 2008,” says Banka. Anticipating these changes is difficult.
The drawdowns can be severe. “A sector that falls out of favour may remain so for a prolonged period,” says Banka.
Maheshwari points out that systematic investing may not be effective in these funds where entering and exiting at the precise time is crucial. Numerous NFOs are launched based on sectors/themes that are doing well. “Investors purchase these funds based on past returns. Yet, many lack the capability, or access to advice, on the right time to exit, leading to steep losses,” says Maheshwari.
Maheshwari points out that systematic investing may not be effective in these funds where entering and exiting at the precise time is crucial. Numerous NFOs are launched based on sectors/themes that are doing well. “Investors purchase these funds based on past returns. Yet, many lack the capability, or access to advice, on the right time to exit, leading to steep losses,” says Maheshwari.
Can you handle drawdowns?
These funds demand high risk appetite. “Only investors who can handle a 20-25 per cent or higher downturn should consider them,” says Banka. They are best suited for experienced investors who can assess which sectors or themes are likely to outperform or those with access to an advisor. Maheshwari says investors who actively monitor the markets and can exit just before a sector tanks may go for these funds. Investors working within a sector, who have insights about its prospects, may also invest. Investors with a low risk appetite, including novices choosing their first fund, should steer clear.
Mean reversion is inevitable
Keep these funds in the satellite portfolio. Banka says exposure to a particular sector/theme should not exceed 5 per cent of the equity portfolio, while exposure to all sectors and themes cumulatively should not exceed 20 per cent. Gang suggests taking exposure to sectors and themes through a mix of active and passive funds. “In case of very large sectors or themes, where it is difficult to predict which segment will do well, a passive exposure may work better,” she says. She also favours passive exposure in the case of sectors where the top 9-10 stocks account for 85-90 per cent of the market cap. When selecting a sector or theme, avoid going by past performance. “Reversion to mean inevitably happens,” says Banka.
Maheshwari also emphasises checking out prospects and valuations. “As valuations go up, the chances of making money go down,” she adds.
