Should you invest in thematic or sectoral funds?
Investors have invested nearly Rs 55,000 Crore in thematic funds in the last six months.
Why does it matter?
Mutual funds have witnessed an inflow of Rs 1.4 lakh crore in the past six months, with nearly 40% going into thematic and sectoral funds.
Sectoral and thematic funds are riskier because they are less diversified and have a more concentrated exposure to a particular sector/theme.
Zoom In
Focus is on past returns – Sectoral funds and thematic funds are cyclical & their performance depends on many factors, such as economic conditions, global trends, government policies, market sentiments, etc.
Example – The pharma sector was the top performer after the Covid-19 outbreak in 2020 but delivered negative returns in 2022. The same applies to the infrastructure sector, too. The government announced in 2020 that it plans to invest Rs 100 lakh crore in infrastructure in the next five years & the stocks flew through the roof. But by 2022, they had lost steam! And they were back again in 2023.
Volatility – Thematic/Sectoral funds are more volatile than diversified funds because they have concentrated exposure to one sector or theme. Since the portfolio is narrow, most of the funds are invested in the top 4-5 stocks. A downturn in one or two holdings will impact the portfolio returns.
The best example that one can think of here is the HDFC Defense Fund. It had doubled the investor’s money in nine months. However, a closer look at the fund revealed that it had invested over 50% of its portfolio in two stocks, Hindustan Aeronautics and Bharat Electronics, which made it risky.
What next?
Who should invest? – Investing in sectoral/thematic funds isn’t for all investors due to the inherent risk. Moreover, the exit time is critical as thematic/sectoral funds are based on market cycles. And it becomes difficult to find one! They should never form the core strategy of your portfolio. Your core strategy should revolve around diversified schemes.
Focus on your financial goals – If you only use past returns or current trends as a parameter to invest in mutual funds, you’ll end up in an endless loop of fund hopping. Instead, focus your energies on achieving your financial goals through a systematic and structured approach.
Asset allocation – You need to have a balanced approach to investing. Just as a balanced diet is vital for our long-term health, a balanced portfolio is essential for long-term investing growth.
Diversification – To avoid being swayed by extreme outcomes, investors should bring diversification to their portfolios. Like cricket, where you need fast bowlers, spinners, batsmen, and all-rounders to win a game, you need various asset classes to invest well.