Does your mutual fund portfolio need Sectoral and Thematic Funds?

Updated: 30 Jul 2022, 05:25 PM IST

  • If you time your entry well, then you can no doubt make a lot of money. But if you get it wrong, then you will suffer badly. Remember, that once a sector does well and you enter late, it might be years before the sector gets back in favour again.

A shopper hands the Indian rupee banknotes to a vegetable vendor in Mumbai, India, on Wednesday, July 20, 2022. The rupee slid to all-time low of 80.06 per dollar on Tuesday, and has lost 2.4% over the past month, the third-worst performing Asian currency over the period. Photographer: Dhiraj Singh/Bloomberg

Have a look at the table below that shows the average returns of the sectoral and thematic funds over the last few years. The green and red colours highlight the highest and lowest category returns for each year:

Thematic funds returns over the past few years

Every year, some sector or theme will do much better than broader indices like Nifty or Sensex. So investing in sectoral/thematic funds does have an understandable appeal. It’s easy to get attracted to high returns that these general every once in a while.

But if you look again at the table, you will see almost every year, there is a new winner. So in 2014, the MNC companies theme did best. In 2015, it was Pharma. Followed by Energy in 2016, Infrastructure in 2017, Technology in 2018, Banking in 2019, Pharma in 2020 and then Technology again in 2021.

So there is an ongoing game of musical chairs at the top. Also, once a sector or theme does well in a given year, it almost invariably doesn’t do well in the next year or two.

But predicting the best sector or theme for the next year is not as easy as it looks. If it was, investing would have been easy and everyone would have been richer. But we will discuss this aspect in detail a bit later. But first, let’s get the basics right.

Difference between Sector and Theme

A sector consists of stocks from a single sector (like banking, technology, etc.) So a Sectoral fund will only invest in stocks of a sector. On the other hand, theme is broader and can encompass more than one sector. An example of a thematic fund can be an infrastructure fund which has stocks from different sectors like energy, oil & gas, construction, mining, capital goods, etc.

As you might have guessed by now, sectoral funds are more concentrated than thematic funds. There is no opportunity to diversify outside the chosen sector for the sectoral fund managers. But the same is possible to a small extent in thematic funds due to their broader canvas.

Coming back to why its not easy to get your sectoral/thematic bets right.

Why it is difficult to be right with Sectors/Themes?

As we saw in the table earlier, there is always a new sector at the top each year. So practically speaking, you can’t be getting in and out of a sector every year. Also, many sectors (themes) can take years to play out well. So having the patience to wait for good days is another challenge for most. In a way, it’s like trying to ride a wave that you expect to rise soon. So you need to get your timing ride with such concentrated bets.

If you time your entry well, then you can no doubt make a lot of money. But if you get it wrong, then you will suffer badly. Remember, that once a sector does well and you enter late, it might be years before the sector gets back in favour again.

It may not be wrong to say that if you are serious about getting your sectoral bets right, you need to have a good level of understanding the sector.

Should you invest in Sectoral/Thematic Funds?

Here are a few points to help you decide:

  • For most small investors who follow a balanced or moderately aggressive strategy, it’s not worth it. Avoid sector and thematic funds.
  • But if one has a higher risk appetite and a large dose of patience, then these can be given a try it. Those investors who are well-informed about a sector and what drives it might be in a better position to take such concentrated bets.
  • In any case, exposure should be limited to 10-15% of the overall equity portfolio. These funds should not form the core of your portfolio as anything about 10-15% will expose the portfolio to a much higher concentration risk due to the nature of these funds.
  • These funds are not buy-and-forget kinds. You have to get your timing right when it comes to entering and exiting these funds.
  • You might be tempted to but avoid entering into these funds after a year or two of great returns. As we saw in the table earlier, sectors generally do poorly after 1-2 years of a good run.
  • If you are already investing in fund categories like flexicap, multicap, large & midcap funds, then do check how the sector/theme you are interested in is already represented in these funds. Let’s say you want to bet on the Indian financial theme. Now if you check the largest funds in flexicap, multicap and large&midcap categories, then you will see that financials already have 25-30% allocation in these funds (as per June-2022 data). So will adding extra sector/thematic funds be worth it? Think about it.

That’s it. Just to repeat, most investors can skip sectoral and thematic funds without any problem. First focus on building a well-diversified portfolio of funds from categories like largecaps (active/passive), flexicaps, large&midcaps, midcaps, etc. Once the base is set and rolling for a few years, only then think about intentionally tilting your portfolio allocation via sectoral or thematic funds.

Dev Ashish is a SEBI-Registered Investment Advisor and Founder (Stable Investor). He provides fee-only financial planning and investment advisory services to small and HNI clients across India.

First Published: 30 Jul 2022, 05:02 PM IST