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What Do You Need to Know About Sectoral and Thematic Funds

What Do You Need to Know About Sectoral and Thematic Funds

Within the first three months of the 2024-25 financial year, the Economic Times reported that about 33% of gross inflows in equity mutual funds were in sectoral or thematic funds, which are usually the “trending” or “hot” sectors. Many investors tend to chase trends when it comes to investing. However, experts advise against this behaviour since it can pose high risks and derail their financial plans. This article will explore sectoral and thematic funds, their functions, and who should invest in them.

What are Sectoral or Thematic Mutual Funds?

1. Sectoral funds

These funds invest solely in specific economic sectors. Sectoral funds are open-ended equity funds that invest in popular trends or sectors, such as real estate, IT, banking, and more. As per SEBI regulations, sectoral funds must invest at least 80% of their AU in a particular sector. For example, real estate sectoral mutual funds must invest 80% of their AUM in the stocks of real estate companies. These funds benefit those seeking long-term capital growth and investment in equity-related securities.

2. Thematic funds

On the other hand, thematic funds invest in popular areas of the market rather than specific sectors. Simply put, thematic funds make vicarious investments that follow a particular theme. For example, an infrastructure thematic fund may invest in the stocks of steel, construction, cement, electricity, and other companies. They are more diverse than sectoral funds. Thematic funds have more significant potential for long-term gains. They are good options for those wanting to invest in equity and equity-related companies related to the theme in which they are interested.

What are the Advantages of Investing in Sectoral/Thematic Funds?

There are many advantages associated with investing in sectoral or thematic mutual funds. These include:

1. There is a high potential for significant returns, primarily if the chosen sector performs well. 

2. These investments can provide grounds for diversification since stocks from any company in the sector can be added to the fund, regardless of market capitalization. This diversification also mitigates risks. 

3.  Sectoral and thematic funds best suit well-seasoned, aggressive investors. They are particularly beneficial for those interested in making long-term investments.

What are the Risks Associated with Sectoral and Thematic Funds?

Sectoral and thematic funds often concentrate on specific sectors. This concentration means many potential risks are associated with investing in them, such as market volatility, political developments, and more. Before investing in one of these mutual funds, some factors to consider include:

  1. Lack of Diversification: Thematic funds concentrate on a single sector or theme, increasing the risk for investors if that sector underperforms.
  1. Higher Drawdown: Sectoral and thematic funds are susceptible to higher drawdowns during downturns in the market if they invest heavily in sectors facing challenges.
  1. Cyclical performance: Sectoral and thematic funds are cyclical, with returns depending heavily on the performance of the industry they invest in. This also means they can undergo long periods of low returns. For example, the infrastructure sector did well in 2017 but saw a reduction in returns in 2018. 

Who Should Invest in Sectoral and Thematic Funds:

Sectoral and thematic funds are well suited for the following investors: 

1. Experienced and Well-informed Investors: Sectoral and thematic funds are best suited for investors with a good understanding of different sectors and well-established portfolios. To benefit from these funds, investors must be able to select the right sector and time their entry and exit well. 

2. High Risk Appetite: Sectoral and thematic funds are volatile investments. Experts suggest that those who are able to handle downturns of more than 20% can consider them. 

3. Investors looking for Long-Term Returns: Certain themes and sectors can take several years to reach their full potential. They benefit investors who are looking for long-term returns, rather than short-term gains. 

Wrapping Up

Thematic or sectoral investing is usually advised for seasoned investors with portfolios who can make well-thought-out judgments on a particular sector. However, many new investors also get caught up in significant investments in trending sectors and themes without having a core portfolio to fall back on. 

Starting your investment journey can seem challenging. Consider Tata Capital Wealth to provide expert guidance and help you meet your financial goals. To learn more, visit the Tata Capital Wealth website today!

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