How To Choose The Best Sector And Thematic Funds?

Sector and thematic mutual fund schemes have been gaining popularity, not just globally, but right here in India. According to the Association of Mutual Funds of India (AMFI), there are now 161 sector and thematic funds, with 64 of them launched since 2020. This surge in new funds shows how these investment options are becoming a favourite among investors, advisors, and distributors. However, because of their unique characteristics, picking the right ones requires some careful thought. Here's a straightforward guide to help you profit from sector and thematic funds.

Understanding the Popularity and Performance

Sector and thematic funds have seen significant inflows, particularly among new fund offers (NFOs) launched between January 1, 2023, and March 31, 2024. According to Value Research data, these funds were among the highest in terms of inflows. Of the ten largest funds by assets under management (AUM) in this period, five were sector/thematic funds, including the SBI Energy Opportunities Fund (Rs 7,454 crore) and SBI Dividend Yield Fund (Rs 6,935 crore). Furthermore, in May 2024, the HDFC Manufacturing Fund, a thematic fund, collected close to Rs 10,000 crore in its NFO.

Who Should Invest?

Sector and thematic funds are not suitable for all investors. These funds should be considered as supplementary investments that add a specific flavour to your portfolio, focusing on particular sectors or themes. The Securities and Exchange Board of India (SEBI) requires these funds to invest at least 80% of their corpus in the sector or theme they track.

Investors should be prepared for the inherent risks associated with these funds, as the success of these investments heavily depends on the performance of specific sectors or themes. It's crucial to have a high-risk tolerance and the ability to handle potential disappointment and principal loss if the sector or theme does not perform as expected.

Finding the Best Theme

Identifying the best sector or theme requires a close reading of the economy and market trends. For instance, consumption is a theme that is often recommended for long-term investors due to its strong growth potential. Investors are advised to look for themes that are evident in their daily lives, such as the consumption of everyday goods, infrastructure development, or technological advancements.

Recent thematic funds have evolved to include a broader range of companies within a theme. For example, a banking and financial services fund might also encompass insurance, asset management, fintech, and housing finance companies.

SIP or Lumpsum?

The traditional advice for mutual funds is to invest through systematic investment plans (SIPs). However, sector and thematic funds might require a different approach. SIPs can be a safer way to start, especially if there is uncertainty about the theme's performance. For instance, the PSU theme initially did not perform well but eventually paid off for SIP investors in its fourth year.

However, for themes with shorter durations due to macroeconomic cycles, a lump sum investment might be more appropriate. Long-term themes such as consumption, banking and financial services, healthcare, and technology can be approached with SIPs.

Allocation and Investment Duration

It's crucial to limit your exposure to the sector and thematic funds to mitigate risk. Experts recommend that no more than 20-30% of your overall portfolio should be allocated to these funds. This strategy ensures that even if the theme does not perform well, it will not significantly impact the broader portfolio.

Timing your entry and exit is also essential. Different sectors go through phases of outperformance and underperformance, so monitoring market conditions and sector valuations is critical. For instance, high-beta funds like transportation and infrastructure may require more active management and timely exits, whereas long-term trends such as fast-moving consumer goods, pharmaceuticals, and banking can be held for longer periods.

Final Thought

Sector and thematic funds offer exciting opportunities for investors willing to take on higher risks for potentially higher rewards. By conducting thorough research, maintaining a disciplined approach, and working closely with financial advisors, investors can successfully navigate these investments.

Proper allocation, patience, and a keen eye on market trends can help maximize the benefits of sector and thematic funds, making them a valuable addition to a diversified investment portfolio.