Sector and thematic mutual funds are growth-oriented equity schemes that aim to achieve capital appreciation by investing in stocks belonging to a single sector or in stocks that are closely related to a particular theme. These funds take concentrated and risky bets when compared with diversified funds. Equity diversified funds invest their assets across sectors.
In the hierarchy of the risk pyramid, sector funds are placed at the top, given their higher risk, followed by thematic funds and then diversified funds.
Sector and thematic funds are suited for investors with the ability to bear high risk. However, these can be a good hedge in the short to medium term, when the broader market appears weak and if one is able to pick the right sectors.
Sector funds are available for the FMCG, pharma, technology and the auto sectors. Thematic funds are available for themes such as contra, dividend yield, infrastructure, MNC, PSU and shariah.
Sector, thematic and diversified
Sector and thematic funds by nature are more prone to risk and volatility. They are high-risk, high-return funds. Both are riskier than diversified funds. However, sector funds are riskier than thematic funds as the performance of sector funds depends on the fortunes of just one or two sectors. A sector fund performs very well when the sector(s) in which it invests does well. But when that sector does badly, the sector fund falls the hardest, given its lack of diversification.
Thematic funds are less risky than sector funds as their fortunes depend on three to five sectors. Since they are semi-diversified, the risk is somewhat mitigated, vis-à-vis sector funds.
Sector and thematic funds are also more volatile than diversified schemes as the risk in the latter is low due to the allocation in the securities of many industries. Sector and thematic funds have restrictions in their investment options and have to continue to invest in the particular sector or theme even if that sector or theme is not doing well. On the other hand, diversified equity funds have the leeway not only to pick the best performing sectors but also to remove ones that fare poorly.
Sector funds move in cycle
Even though sector and thematic funds have a potential to fetch better returns than other equity-oriented funds, based on developments in the sectors, one cannot expect consistent returns over periods as sector funds tend to move in cycles.
For example, the information technology sector was at its peak in 2005-06. But it was among the worst-performing sectors in 2007-08. The sector moved to the top slot again, in 2009. Likewise, 2007-08 was the best performing period for the infrastructure industry but infra stocks underperformed over the next four years. The pharma sector that had outperformed between 2010 and 2015 is now an underperformer.
Hence, the performance of these funds is linked to the fortunes of the sectors. The funds do well if the respective sectors perform well. However, some of sector funds over the long run outperform even the diversified equity funds given their prudent fund management.
The Table exhibits the relatively better performing schemes from sector and theme-based equity mutual funds. However, investors with a low risk appetite should avoid investing in these mutual funds.