Sector & Thematic Funds: Look Before You Leap

Sector & Thematic Funds: Look Before You Leap 

Mutual funds allow investors to invest in equity market through a variety of funds. There are large-cap, mid-cap, small cap, multi-cap, contra/ value fund, sector and thematic fund as well as equity-linked savings schemes. The mix of funds in the portfolio of an investor should be in line with his/her capacity to take risk, experience of investing in market-linked products and the size of the portfolio. 

In the current market situation, some of the sector and thematic funds usually catch investors’ fancy due to superlative short and medium-term performance. Since sector funds ride on industry cycles, they have the potential to offer attractive returns if the timing is right, albeit with higher level of volatility. At the same time, they do not provide downside risk protection available in diversified funds. 

Similarly, thematic funds look for trends that are likely to result in outperformance of certain sectors or companies. In other words, the key factors are those that can make a difference to business profitability and market values. They focus on structural as well as cyclical factors that play an important role in the economy. 

Here’s what you should know about sector & thematic funds 

A sector fund can be a great option for investors who understand a sector as well as its future potential and seek diversification within that sector. Besides, these funds can play a supporting role to a diversified portfolio by allowing investors to increase exposure to those sectors that may be under-represented in the portfolio. 

Even for those who invest in stocks directly, sector funds offer advantages over individual stocks as the fund manager tracks the industry/sector development for its investors. Since the performance of sector funds fluctuates depending on how their particular sector/industries are performing in the market, a wrong selection of sector/s can adversely affect the overall portfolio return. Therefore, for a sector fund investor, it is essential to have the ability to withstand the short-term fluctuations in order to enhance long-term returns. 

Like sector funds, thematic funds also carry a high degree of risk. However, they are more diversified than sector funds as they invest in sectors that are likely to benefit from a theme. In other words, thematic funds also are suitable for investors who have the experience of investing in equity and equity funds and have higher risk appetite.

Remember, there is always a risk that the market may take more time to recognize views of the fund house with regards to a particular theme which forms the basis of launching a fund. Besides, there can be ambiguity in fund’s definition of a theme. There is also a risk of a fund manager’s style becoming too individualistic, which may be difficult to follow if he decides to leave the fund.

Follow a strategy for investing in these funds 

Broadly speaking, these funds should constitute only a limited portion of one’s portfolio. Simply put, if one has already built a well-diversified portfolio and can withstand extreme volatilities, these funds can contribute handsomely in improving the overall portfolio returns. 

One can adopt different strategies to reduce the risk generally associated with such funds. One such strategy is to have a small exposure to 3-4 sectors/ themes. It is also advisable to review one’s portfolio to ensure that one is not investing in a sector/theme that already has a sizeable exposure through other funds. Besides, one should have the capacity to hold these funds for the longer term if required and must curb the urge to switch from one sector/theme to another. 

As a thumb rule, for someone who has a decent exposure to equity funds and is conversant with the behavior of equity market, around 10-15% of the portfolio can be invested in sector and thematic funds. The key is to select the funds carefully and monitor the progress over the investment period