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Role of Sectoral & Thematic Funds in your Portfolio

The phrases - sectoral fund and thematic fund are used fairly commonly and most mutual fund houses have launched schemes that would qualify for one of the categories.

Published: 30th August 2021 10:14 AM  |   Last Updated: 30th August 2021 10:14 AM   |  A+A-

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The phrases - sectoral fund and thematic fund are used fairly commonly and most mutual fund houses have launched schemes that would qualify for one of the categories. But what do these funds mean and how should you be analysing them in the context of your investments?

As you would be aware, companies listed on the exchanges operate in various industries, whether it is pharmaceuticals, or steel, in some kind of service like banking, hotels etc. Sectors are very similar to industries, but may typically include one or few closely-related industries. Examples relevant for the above mentioned industries would be Healthcare sector, Metals sector, Banking & Financial Services (BFSI) sector and Travel & Tourism sector respectively. Sectoral funds define which sector they would be investing into, in their offering document.

I like to see this as maybe slicing the market. So if for a moment, we assume the market is like a cube, sectors are like slices of the cube. If you invest in a particular sectoral fund (slice) you will get exposure only to that slice of the market.

Staying with the assumption above, instead of slicing vertically which provides you with the sectors, if you slice the markets horizontally, you would get the market cap-related funds - these would be the large-cap funds, the mid-cap funds and the small-cap funds. These funds will invest across sectors, but only in the market cap range that has been pre-defined in the scheme offering document.

Thematic funds are a bit more complicated, these funds try to have some common factors that would be the characteristics of the underlying companies. A classical example for a thematic fund is a High-Dividend-Yield fund, where the underlying companies can be from any sector and of any market cap, but they have a common feature where the dividends paid by the company provide an attractive yield on the current market price.

Another example of thematic funds would be a Commodities fund, which then encompasses anything that is produced and sold in bulk without much branding. These typically include cement, steel, other metals, basic chemicals and many other products that are produced and sold in bulk i.e not directly to individual consumers. Many other themes can be created such as Interest-Rate-Sensitive - where companies with high debt would be more impacted, or Foreign-Exchange-Sensitive - where companies with high percentage of exports or imports will be more impacted, etc.

As you can see from the above, all these type of funds invest in only a certain pocket of the markets. This makes them a high-risk - high-return option. That is because come what may, these funds are restricted to invest only as per their stated objective. If the particular sector/market cap or theme does well, the returns can far exceed overall returns from the markets, but on the other hand, if the areas where the fund invests do not do well, it may lag the markets significantly. Further, market situations evolve continuously and what is doing well now may or may not do well few months down the line.

Therefore, one has to be careful while investing in the above type of funds. Firstly, you should have a need to invest in them. That need can come from a better understanding of a particular sector etc. For example, if you believe the current pandemic situation will lead to a long term sustainable opportunity for pharmaceutical companies and hospitals, you may want to do some investments in a Healthcare Fund or a need for higher income from the portfolio may require you to invest into high-dividend-yield-funds. 

Your belief needs to be strong and backed by rational arguments rather than a whim or the urge to participate in some current fads. Secondly, you need to be clear that you will be able to monitor these investments on a continuous basis. As we go forward, situations change but the investment scope will remain the same.

You need make appropriate adjustments to your investments as the Fund Manager will be unable to do so, given the restrictions of investing in only the stated set of companies. Sectoral and thematic funds are for better informed investors. If you think you cannot track the markets on an ongoing basis, it may be best to stick to the mainline flexi-cap funds offered by most fund houses. 

On the other hand, if you believe you can spot emerging trends and have the time and inclination to follow markets, sectoral and thematic funds can help boost your overall returns significantly.

When investing,  remember
Your belief needs to be strong and backed by rational arguments rather than a whim or the urge to participate in some current fads. Secondly, you need to be clear that you will be able to monitor these investments on a continuous basis.

(The author is the founder of Five Rivers Portfolio Managers)


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