Sector and thematic funds: Stay invested if you can assess prospects

Sector and thematic funds allocate at least 80% of their portfolios to stocks within a specific sector or theme

Sector and thematic funds, which delivered high returns when the equity market was in a bullish phase, have witnessed sharp declines amid the recent market correction. Public-sector unit (PSU) funds, which delivered 49 per cent over the past year, are down 8.9 per cent over the past month. Infrastructure funds (40 per cent and 8.3 per cent) and consumption funds (28.3 per cent and 9.7 per cent), which also delivered high returns over the past year, have caused erosion of investor wealth over the past month.

 

Sector and thematic funds allocate at least 80 per cent of their portfolios to stocks within a specific sector or theme. While thematic funds are usually more diversified than sector funds, they, too, are more concentrated than diversified equity funds.

 

 

“Sector funds can be volatile as their investment universe is narrow or concentrated due to their focus on the underlying sector. Sharper-than-expected market swings can be expected from them,” says Rajesh Jayaraman, head–products, Nippon India Mutual Fund.

 

What has triggered the correction?

 

Consumption funds, which focus on consumer-facing industries like fast-moving consumer goods (FMCG), automobiles, telecom, and consumer durables, have suffered due to the rise in consumer price index (CPI)-based inflation, which hit 6.21 per cent in October 2024. Lower wage growth has also impacted consumer spending power.

 

“Infrastructure companies depend on cheap capital from abroad. They now face the brunt of rising interest rates in nations like Japan,” says Abhishek Kumar, a Securities and Exchange Board of India (Sebi)-registered investment adviser and founder, SahajMoney.com.

 

Kumar adds that PSU stocks, which rose considerably over the past year, are now under pressure as earnings have not kept pace with expectations.

 

Sector and thematic funds are tied to specific sectors and themes. Companies in these sectors/themes go through their own economic and business cycles. When the cycle is favourable, they can deliver huge profits. But cyclical downturns also adversely affect their performances. Diversified equity funds offer better downside protection due to their ability to move across sectors. 

 

Stay invested or exit?

 

Sector and thematic funds are suitable for mature investors who can evaluate the prospects and valuations of a sector or theme, and make timely decisions on entry and exit.

 

“Investors must not only look at past returns, but also understand the future of the theme, market cycles, and sectoral shifts,” says Siddharth Alok, assistant vice-president-investments, Multi Ark Wealth, Epsilon Group.

 

He adds that investors with confidence in a theme’s valuation and outlook may even use the current 10 per cent market correction to add to their investments.

 

However, investors with limited knowledge and research ability, who entered these funds based merely on their past performance, should consider switching to diversified funds. Downturns in these funds can last for a long time.

 

Investors should also assess their risk tolerance. Investors who have suffered sleepless nights due to recent losses are not cut out for investing in sectoral and thematic funds. These funds can experience far steeper corrections.

 

Those who decide to stay invested must have a time horizon of 5-7 years. Investors with near-term financial goals should shift to less volatile options.

 

According to Jayaraman, these funds should form part of the satellite portion of a portfolio rather than the core.

 

Investors with a moderate risk appetite may allocate up to 10 per cent of their equity portfolio to these funds, while those with a higher risk appetite may consider up to 20 per cent.