Sector Funds: Meaning, Types & Investment
Sector fund or thematic funds have been around for a long time in India. In fact, as per AMFI there are 102 sectoral / thematic schemes in India managing nearly Rs.133,000 crore across these sectoral funds. Most of the sector funds are small in size.
How is a sector fund different from a thematic fund?
In a way, both are same in the sense that they are concentrated. Unlike diversified funds, these sector fund and thematic funds do not spread the money across different stories. On the contrary, they are just focused on one or two sectors. Here is the principal difference between a sector fund and a thematic fund.
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A sector fund invests the large chunk of the corpus only in that particular industry. You have Banking Funds, IT Funds, Pharma funds, FMCG funds etc. These funds invest only in the companies in that particular sector although they tend to broaden the definition a bit to make it more flexible.
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A thematic fund is a slightly broader approach than a sector fund and normally combines 2-3 sectors that represent a theme. For example, Digital Funds can combine IT stocks, banks, fintech companies, online market places etc. Similar commodity funds can have a portfolio consisting of steel stocks, aluminium stocks, oil stocks etc.
Just to summarize, the thematic fund is a slightly broader version of a sector fund
How have the top sector funds / thematic funds performed in India
There are a total of 102 sector / thematic funds managing around Rs.133,000 crore corpus. Here we have captured a list of the top 20 sector/thematic funds based on 1-year returns earned on the fund. For simplicity we have considered the direct funds where the costs are relatively lower.
| Scheme Name | NAV Direct | Return 1 Year (%) Direct | Return 3 Year (%) Direct | Return 5 Year (%) Direct |
| Tata Digital India Fund | 45.79 | 75.16 | 46.51 | 36.66 |
| ICICI Prudential Technology Fund | 189.26 | 75.08 | 47.85 | 35.70 |
| Aditya Birla Sun Life Digital India Fund | 162.15 | 70.20 | 46.78 | 34.65 |
| SBI Technology Opportunities Fund | 181.66 | 66.09 | 42.35 | 30.96 |
| Quant Infrastructure Fund | 22.29 | 81.89 | 37.77 | 27.86 |
| Franklin India Technology Fund | 388.87 | 38.96 | 36.83 | 27.62 |
| Quant Consumption Fund | 62.45 | 58.17 | 33.15 | 25.19 |
| Tata India Consumer Fund | 29.60 | 28.79 | 17.87 | 22.24 |
| Canara Robeco Consumer Trends Fund | 74.31 | 32.08 | 23.60 | 22.23 |
| Mirae Asset Great Consumer Fund | 63.00 | 34.91 | 20.07 | 21.74 |
| BOI AXA Manufacturing | 33.44 | 55.17 | 28.96 | 20.77 |
| Invesco India Infrastructure Fund | 36.47 | 55.99 | 26.84 | 20.77 |
| Tata Resources & Energy Fund | 32.17 | 46.98 | 31.70 | 20.73 |
| Nippon India US Equity Opportunities Fund | 28.00 | 25.67 | 26.65 | 20.70 |
| Tata Ethical Fund | 324.61 | 44.44 | 26.04 | 20.61 |
| SBI Magnum COMMA Fund | 79.01 | 54.49 | 30.96 | 20.14 |
| Aditya Birla Sun Life India GenNext Fund | 151.68 | 31.54 | 21.72 | 19.95 |
| SBI Consumption Opportunities Fund | 199.28 | 34.29 | 17.72 | 19.58 |
| Nippon India Pharma Fund | 334.06 | 21.12 | 28.96 | 19.29 |
| ICICI Prudential US Bluechip Equity | 51.17 | 27.61 | 26.19v | 19.28 |
While we have provided the returns for 3 years and 5 years also, the ranking is done based on 1 year returns. In the above list, technology funds, pharma funds and energy funds are cases of sector funds while digital funds, consumption funds and ethical funds are examples of thematic funds.
What stage of the cycle should one invest in sector funds.
That is an interesting question. You must typically invest in sector fund or thematic funds when the cycle is about to begin or just about started. Later you get into sector funds, the higher the risk of investor ennui. For example, your preferred theme is rural consumption, which is due to the massive infrastructure spending by government and encouragement to agriculture.
Obviously, you will be buying stocks of tractors, fertilizers and agrochemicals when the cycle starts and have the patience to wait. If you buy closer to the peak (like tech funds in 1999 or even commodity funds in 2007), you are going to end up investing at steep valuations. The more you spend time in the up cycle of the sector, the better it is for your portfolio.
What should be my total exposure to sector funds in the MF portfolio?
Obviously, sector funds are not diversified so that they can be part of the core portfolio. But, how much should have in your portfolio. If you are expecting a major up-cycle in banking and you want to allocate 10-15% of your corpus in banking sector funds, it is fine. But don’t allocate 40-50% of your corpus to any sector fund.
That way, you overexpose your portfolio to one or two sectors; defeating the basic purpose for which you invested in mutual funds and that is diversification. Ideally, out of your overall equity fund allocation, sector funds and thematic funds must not cross 10-15% best case.
Is there a risk of downturn in sector funds / thematic funds?
In fact, there is a fairly large risk, which is why allocation limits are important. Downsides can be violent and intimidating. Any sectoral fund has a cyclical risk. Remember, what happened to Technology funds post 2000 and to Commodity funds post 2008. Some of the technology sector funds that came out with NFOs in 1999, saw the NAV fall to as low as Rs.2.50 and Rs.3 in the carnage after the tech crash. That is a risk.
It is not just about IT. For example, post 2008 infrastructure had a huge down cycle and post 2011 capital goods had a huge down-cycle. These sector funds would have been really bad to your portfolio, which is why your stop losses come in handy. The moral of the sector funds story is not to wait till the end of the cycle but take profits off the table once your target is met and revert to the safety of diversified mutual funds.
Is there a checklist i can follow before investing in sectoral / thematic funds?
Of course, there is a checklist and we are providing you with the checklist for the same. Go through these points carefully before you embark on sector funds or thematic funds.
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When you opt for a sector fund or thematic fund, never lose sight of valuations with reference to the historical P/E ratio of that sector. Generally, AMCs launch sector funds at the peak of the market, like we saw IT Funds in 1999 and Infrastructure funds in 2008.
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Don’t get into a sector fund or thematic fund without a stop loss in mind and keep that discipline. For example, you may put a stop loss of 15-20% and at that level just exit the sector fund. These funds may eventually bounce back but that is immaterial to you.
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At the end of the day, earnings and profits don’t lie. Find out if the earnings of that sector are actually growing. If that is not happening, then it is just too much of a risk. It will be exactly like trying to ride the tech boom in 2000.
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Are there enough good quality stocks to invest in. For example, back in 1999, many of the IT funds were even investing in banks that were leveraging on technology. This goes against the very grain of a sector fund. Ensure there is choice for the fund manager.
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Ensure that the thematic fund represents a sustainable theme, not a fad. Defence suddenly looked like a theme, but hardly emerged as an investable theme. Even rural consumption theme is yet to play out in a big way. So, bet on sustenance.
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Finally, apply the affordability test to sector funds and thematic funds. When you have long term goals, don’t depend on sector funds to help you meet these goals.