“The four most dangerous words in investing are: ‘This time it’s different.’”-Sir John Templeton
This quote perfectly fits here, as investors often get carried away by new market trends, believing that past risks may not apply to current opportunities. Sectoral and thematic funds have gained immense popularity in recent years. With asset management companies (AMCs) launching a growing number of these funds and investors eagerly subscribing to them, they have become a significant segment of the mutual fund industry. But are they the right fit for every investor?
These funds focus on specific industries, trends, or themes, such as technology, healthcare, infrastructure, or ESG (Environmental, Social, and Governance), aiming to capitalize on sectoral growth. While the potential for high returns attracts many, the associated risks cannot be overlooked. The crucial question remains: Should investors incorporate sectoral and thematic funds into their portfolios, and if so, how?
The Surge in Sectoral and Thematic Funds
In the past decade, the number of sectoral and thematic funds has surged. As per the AMFI’s data, the Assets Under Management (AUM) in these funds have significantly increased.
This surge in AUM is also on the back of mutual fund houses launching sectoral and thematic funds and the aggressive marketing that follows the New Fund Offer (NFO) of the fund. The NFO is the period when a new fund is open for an initial subscription before it reopens for further subscription.
Investors are also flocking to these funds. We can see that the segment received a net inflows of Rs 9,016.60 in January 2025 up from the Rs 4,804.69 crore inflows in January 2024. It was the highest inflows in the equity segment.
The inflows to large cap funds and flexi cap funds stood at Rs. 4,122.95 crores and Rs. 5,697.58 crores respectively.
The chart compares net inflows across Large Cap, Sectoral/Thematic, and Flexi Cap funds for January 2024 and January 2025, highlighting shifting investment trends.
Given their potential for outperforming broad-based diversified funds during sectoral upcycles, investors find them appealing. However, the key question is whether these funds are sustainable long-term investments or merely a reaction to market fads.
Why the Craze?
Several factors drive the popularity of sectoral and thematic funds:
- Aggressive Fund Launches and Marketing – Fund houses continuously introduce new schemes, emphasizing high past returns and favourable prospects. Sales teams aggressively push these funds, highlighting short-term sectoral momentum.
- Investor Behaviour – Many investors chase performance, seeking the next big opportunity. Thematic investing plays into this behaviour, making it an attractive choice for those looking for high returns.
- FOMO (Fear of Missing Out) – Investors worry about missing lucrative opportunities, especially when they see certain sectors outperforming.
However, the behavioural biases that make these funds appealing also increase the risk of misjudgement. Jumping into sectoral funds at the peak of a market cycle can lead to disappointing results.
Sectoral and Thematic Funds vs. Diversified Funds
Understanding the fundamental differences between these fund types is crucial.
- Investment Focus
- Sectoral/Thematic Funds: Concentrate on a particular industry or theme (e.g., banking, technology, or ESG trends).
- Diversified Funds: Spread investments across multiple sectors, reducing risk and ensuring stability.
- Risk and Volatility
- Sectoral/thematic funds carry higher risks due to their concentrated nature. Poor timing or a downturn in the chosen sector can significantly impact returns.
- Diversified funds, on the other hand, minimize risk through exposure to multiple industries, providing more consistent performance over time.
- Market Timing Matters
- Sectoral and thematic funds can yield excellent returns if investors enter at the right time and exit before the cycle turns unfavourable. However, timing the market is difficult, even for experienced investors.
Portfolio Role: Where Do They Fit?
Given their high-risk, high-reward nature, sectoral and thematic funds should play a specific role in a portfolio:
- They should form part of the satellite portfolio rather than the core portfolio.
- The core portfolio should consist of diversified equity funds, index funds, or asset allocation funds that provide long-term stability.
- Investors should allocate only a small portion (typically 10-15%) of their portfolio to these funds to enhance potential gains without overexposing themselves to risk.
What Should Investors Do?
If you are considering sectoral and thematic funds, follow these essential guidelines:
- Prioritize Asset Allocation – Before investing, ensure your core portfolio is well-structured with diversified equity funds and a balanced asset allocation strategy.
- Limit Exposure – Do not allocate more than 10-15% of your total investments to sectoral/thematic funds.
- Invest in What You Know – Investors should consider funds in sectors where they have expertise. For example, IT professionals may have an advantage in investing IT sector funds.
- Avoid Chasing Trends – Resist the temptation to invest in funds based solely on past performance. Focus on long-term sectoral fundamentals instead of short-term hype.
- Have an Exit Strategy – Since sectoral cycles can be volatile, define an exit strategy to lock in profits and reallocate funds when necessary.
Conclusion
Sectoral and thematic funds can be valuable additions to an investor’s portfolio but must be approached with caution. While they offer significant upside potential, they also carry substantial risks. Investors must ensure that their core portfolio remains diversified and that any allocation to these funds is limited and strategically planned.
The key takeaway? These funds can be rewarding, but they are not for everyone. Success with sectoral and thematic investing requires careful selection, disciplined allocation, and an informed approach to market trends. If used wisely, they can enhance returns without jeopardizing overall portfolio stability.
Prasad Iyer
[Certified Financial Planner – CFP CM]
