Beware! before you invest in Sectoral/Thematic Funds

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Most sectoral and thematic funds, especially the ones in the technology and healthcare sectors, have outperformed the broader market (S&P BSE 500) by a substantial margin since March 2020. Such funds are becoming investors’ favorites. The net assets AUM under the management of sectoral funds rose 79% in April this year.

What’s drawing investors?

 The stock market collapsed by around 40% after the outbreak of Covid-19 early last year. After the declaration of massive fiscal and monetary stimulus across the globe, followed by vaccine discovery and roll-outs, equity markets bounced back significantly.

Harshad Chetanwala, co-founder, MyWealthGrowth.com, says some of the thematic and sectoral funds have performed well in the last year due to the market correction in 2020 added by the pandemic and lockdown which helped a few sectors to perform better. Many investors are looking at the short-term performance and wish to add these funds to their portfolio, hence the interest around sectors like pharma, information technology, banking, and consumer discretionary and their respective funds is growing.

Also, Dhaval Kapadia, Director, Morningstar Investment Adviser (India), adds that with the economy on a road to recovery at 7.3% in FY21, cyclical sectors such as financials, basic materials, and industrials are likely to do well as the economic recovery picks up. However given the uncertain pandemic, he still suggests to stick to long-term asset allocation and invest the majority of the portfolio is well-diversified fund and to avoid concentration in just a single sector/theme.

What to look out for?

 Certain factors to be kept in mind while investing: Sectoral funds come at a much higher risk as their performance depends on the sector. They are cyclical and extremely volatile compare to other equity diversified funds. If the sector underperforms, fund managers won’t be able to protect the downside effect/level.

Chetanwala reminds investors that different sectors have different potential and that mainly they are cyclical. The theme may be infrastructure, consumption, energy, healthcare, etc. for the time being, but it is not advisable to invest in them by looking at last one-year returns.

What should investors do?

 Kapadia advises investors to limit exposure to such funds to less than 5-10% of the portfolio. He says that one should be firm while going for these funds and be ready to ride any type of volatility and should remain invested till it plays out. One should be flexible with these funds and exit at once when the sector seems to have outperformed the market.  

 Brijesh Damodaran, managing partner, BellWether Associates LLP, says investors must observe the ups and downs in the sector and catch the trend early. He also suggests that investors should consider the time horizon, cash flow, and liquidity needs before investing in thematic sectors as the ecosystem is extremely fluid and volatile. Also, one should keep an eye on policies affecting the sectors.

 Chetanwala says these funds have a concentrated portfolio with limited companies which can be risky and also the fund has the mandate to follow the sector irrespective of the timing of the market. Sectors like Banking and Financial Services, IT, offer better consistency in the long run compared to others.

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