Sectoral, thematic mutual funds gaining popularity: 4 factors that attract investors

The Assets under Management (AUM) of sectoral/thematic funds have increased by 30% to ₹2.18 lakh crore in October 2023 from ₹ 1.68 lakh crore in October 2022.

Mutual funds have become a popular investment category. However, investors must invest in suitable mutual funds that align with their goals and risk tolerance.

Data from AMFI shows that the investors’ interest in sectoral/thematic funds that invest in specific sectors, such as PSU companies, has grown more than diversified funds that invest in various sectors.

The AUM of sectoral/thematic funds has increased by 30% to ₹2.18 lakh crore in October 2023 from ₹ 1.68 lakh crore in October 2022. In the same period, the flexi cap funds' AUM has increased by 16%. The attractive returns of these funds are just one of the reasons behind the attraction of sectoral/thematic funds. 

For instance, PSU thematic funds are currently ranked second in the 1-year returns chart with 33.32% and tops the 3-year returns chart with 35.80% returns. Anyone would be tempted to invest in these funds by looking at this data at insolation.

In this article, we will see what’s driving investors to invest heavily in these funds and what they should do.

Greed and fear cycle

The greed and fear cycle is a recurring theme in the equity markets. Investors invest when there is hype in the market and sell their investments when the markets make a downturn. Many investors invest in the market after seeing their friends make a lot of money by investing in certain sectoral funds. This greed later converts into fear when they see their portfolio in red.

“Since 2020, a lot of new investors have jumped into the market. It's become super easy to start investing, especially from the comfort of your own home. But here's the thing – many of these folks don't really get the whole deal with sectoral funds. Back in 2007, for instance, infra funds were on fire, and tons of people rushed in. In 2017, it was the auto sector and now it is PSU. It is the greed and fear cycle that is always at play. These trends don't last forever, and when they fizzle out, it's the retail investors who get hurt," said Gajendra Kothari, Managing Director & Chief Executive Officer, Etica Wealth Private Limited.

Lack of goal-based financial planning

Most investors who invest in sectoral funds/thematic funds need goal-based financial planning.

“Investing without a clear plan and relying on random choices can be quite risky. However, I see that too many people invest their additional funds into sectoral/thematic funds without aligning them with their goals. They are missing the whole point that investments are meant to fulfil your goals,” said Preeti Zende, SEBI Registered Investment Advisor, Founder of Aapanadhan Financial Services.

AMCs pushing sectoral and thematic funds

Another reason that increased the assets of sectoral/thematic funds is the introduction of new sectoral funds. According to the AMFI’s monthly data, the total number of sectoral/thematic rose from 123 in October 2022 to 142 in October 2023.

“A good number of sectoral/thematic funds have been launched in recent times to garner assets and ride the popular theme at that point in time. So, I would say that this is more of an AUM adding strategy used by mutual funds. Sector funds can gather assets well through distribution networks, especially if recent returns are high,” said Vidya Bala, Co-founder PrimeInvestor.

Overconfidence bias

Overconfidence might also be another reason behind the rise in the interest in sectoral funds. Investors believe that they can replicate the high returns consistently.

“People are confident and tend to think they've got it all figured out, but they often end up learning the hard way from their own mistakes,” said Gajendra Kothari.

Preeti believes timing is crucial for sectoral investment, and this is where most people get it wrong.

“It’s crucial to approach investments with a calculated mindset. People often get swayed by the news and change their strategies accordingly. Market trends tend to be cyclical, and betting on the right trend can indeed pay off. Take the government's infrastructure initiatives, for example. These activities span over a decade or more. So, an investor needs to be patient with their investments in order for the strategy to play out,” said Preeti.

Vidya adds that many investors believe that sectoral/thematic funds are like diversified equity mutual funds. “Investors are not aware of the higher risk associated with investing in sectoral/thematic funds. Sectoral funds are suitable only for investors who understand the sector and know the time of entry/exit in such sectors,” said Vidya.

What to do?

It is smarter to have a diverse portfolio and make investments to fulfil financial goals. Sectoral/thematic funds should ideally be at most 10-15% of the investor's equity portfolio. Investors already investing in diversified equity mutual funds can invest in sectoral funds that will boost their overall portfolio.

“If you're thinking about investing in sector-specific stocks or thematic funds, treat them as an addition to your satellite portfolio. Use surplus funds after securing your core portfolio, which should align with your financial goals,” said Pretti.

Padmaja Choudhury is a freelance financial content writer. With around six years of total experience, mutual funds and personal finance are her focus areas.