Everything You Need to Know About Sectoral or Thematic Funds

Novice investors are often confused about whether to invest in aggressive mutual funds to generate returns or focus on conservative investment options like low to moderate-risk mutual funds to earn returns. As we all know, risk and returns go hand in hand. The high return generating mutual funds, such as sectoral and thematic funds, can expose you to higher risks that might not be suitable for investor risk profile.

What are Sectoral Mutual Funds?

Sectoral Mutual Funds are sector-specific funds that mainly invest in companies from one particular sector. For example, pharmaceutical funds primarily invest in pharmaceutical companies. Similarly, there are several sectoral funds, such as banking, information technology, energy & power, consumption, auto, etc.

What are Thematic Mutual Funds?

Thematic Mutual Funds invest in sectors or businesses operating within a common theme. For example, a thematic fund that is focused on an agricultural theme might invest in equity stocks of core agricultural companies, farm equipment & automobiles, chemicals, fertilisers, etc. Infrastructure, Rural India, ESG (Environment, Social, Corporate Governance), consumption, services, MNC, PSU, etc. are some more examples of thematic funds.

Sectoral and Thematic funds are equity mutual funds as they typically invest in equity and equity-related instruments. They take exposure to a particular sector or theme as per the mandate and within the sector or theme, they aim to benefit from the growth potential of companies that are likely to do well in the overall macroeconomic and business environment. However, timing the market perfectly and consistently is nearly impossible; hence, it is the biggest risk associated with sectoral and thematic funds. Investors may even suffer a loss if the underlying sector or theme comes under pressure or is out of favour for a long time.

What are the similarities between sectoral funds and thematic funds?

• Sectoral and Thematic funds are equity-oriented mutual funds that primarily invest in equity and equity-related instruments of the pre-specified sector or theme.
• They invest across small-cap, mid-cap, and large-cap companies within their respective sector or themes.
• Since the sectoral and thematic funds concentrate on a particular sector or theme, they are considered high-risk funds and are ideal for investors who are willing to take higher risks.
• Both the fund types are highly volatile and have higher downside risks.
• Sectoral and Thematic funds are taxed like any other equity-oriented funds.

What are the differences between sectoral and thematic funds?

Who should invest in sectoral and thematic funds?

• While sectoral and thematic funds have the potential to earn higher returns, they are highly volatile and carry very high risk. Hence, investors who have high-risk tolerance can invest in them.
• Investment in sectoral and thematic funds requires timing the market perfectly. Therefore, in-depth knowledge and understanding of sectoral nuances are required.
• Since these funds are highly volatile, they are ideal for investors with a very high-risk appetite and long-term investment horizons.
• While sectoral and thematic funds may meet the return expectations in the short term, they can derail and take a long time to recover in the long run and hence requires investors to be vigilant.

What are the things to look for when investing in sectoral and thematic mutual funds?

1. The fund should have a strong track record of at least 3 to 5 years.
2. It should belong to a fund house with a good track record.
3. It should offer diversification across multiple stocks.
4. The scheme should be amongst the top performers in its respective category.
5. The fund manager should be experienced and competent.
6. The fund house should have well-defined investment systems and processes in place.
7. The scheme should abide by its stated objectives, indicated asset allocation, and investment style.
8. Instead of looking only at the past or current performance of the scheme, you should consider the future potential of the sector or theme.
9. When investing in sectoral and thematic funds, it is crucial to understand the best entry and exit time within the sector or theme.

Should you invest in sectoral or thematic funds?

Most new investors invest in sectoral and thematic funds by merely looking at their past performance, which is not a good investment approach. Investing in such high-risk funds requires in-depth market knowledge and understanding of the underlying sectors. Bear in mind that the sectoral and thematic mutual fund schemes are highly volatile compared to diversified equity funds. Hence, it is advisable to build a portfolio through diversified funds.

Above article is authored by Quantum.

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