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Vaibhav recently spotted a lucrative investment opportunity in the FMCG sector. He is interested to take the benefit of the equity wave. However, he lacks the requisite investing acumen. He thinks venturing out in the waters would be pretty risky without proper knowledge.

You, like Vaibhav, may desire to take the advantage of such short-term opportunities but don’t know how to go about it. You can go for sector and thematic funds!

Sector funds and thematic funds belong to category of equity mutual funds. These funds are stark contrast to diversified equity funds.

Sector funds focus on specific sectors or industry like banking, pharma, information technology, real estate, energy, etc.

Thematic funds, on the other hand, invest in stocks which are well-defined around a particular opportunity. These might look similar to sector funds but may consist of several sectors. You may perceive these to be much more diversified than sector funds.

Advantages of investing in Sector and thematic funds

If you invest your money in a sector that has high-growth potential, you’ll notice that the funds tend to increase substantially in price when the product demand is high. So, if the growth trend for that particular sector or theme predicts continual demand, then your investment is a good one.

Risks of investing in Sector and thematic funds

While higher growth in the chosen sector represents good news for the investor, a downturn in the sector represents heavy losses. The reason behind this is the lack of diversification in holdings.

Investing in a sector fund is equivalent to putting all of one’s eggs in one basket; if the basket were to fall, the eggs would all break.

Thematic funds, although more diversified than sector funds, are also dependant entirely on one particular theme.

Things to bear in mind before investing in sector and thematic funds

Before investing in sector or thematic funds, it is recommended that you keep the following points in mind:

  • It is advisable to own a diversified portfolio comprising of regular funds before going ahead with sector or thematic funds. Sector and thematic funds are known for their higher risk and volatility, which means investing more than 10% is a huge risk for any investor

  • Sector and thematic funds are suitable for those who have an understanding and in-depth knowledge of that particular sector or theme

  • Be aware of exit timing especially while investing in sector funds, because sector funds are cyclical in nature

  • Don’t go by past returns when you invest in a sector or thematic fund. Rather, take a good look at the opportunities ahead for that sector or theme

Should you invest in sector and thematic funds?

Sector and thematic funds are a great way of enhancing your portfolio if you have patience to bear cyclical fluctuations and have a long-term perspective.

A keen understanding of the sector or theme is important because in such funds you play the role of the fund manager. The timing of the investment must be carefully decided. There’s no point in entering the sector or theme when it has already delivered. Also, the exit timing must be carefully administered to get the best returns.

While sector and thematic funds can give you high returns when they are doing well, the downside can erode your gains very quickly.

The following table shows how different sector fund categories have done in comparison to diversified multi-cap equity funds over different time periods.

Sector funds versus diversified equity funds
1-year returns (%) 3-year returns (%) 5-year returns (%) 10-year returns (%)
Diversified equity funds 21.74 14.57 18.50 9.84
Infrastructure funds 29.59 15.36 17.19 4.22
Banking funds 25.71 15.97 15.40 13.39
FMCG funds 22.18 15.42 16.72 18.41
Pharma funds -9.39 3.85 15.79 15.27
Technology funds 10.32 4.18 15.98 8.61

As on 30 October 2017

It is also important to note that if a particular sector is expected to do well, the fund manager of a diversified mutual fund would also have exposure to that sector. Hence, you won’t be missing out on a hot sector or theme if you are investing in a diversified mutual fund.

Sudden losses and sudden gains are a part of sector fund investments. So be prepared to keep a keen eye on the economic progress of your chosen sector and be prepared to exit quickly.

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