Investing in sector and thematic funds

Asset management companies continually launch new fund offers (NFOs). In the recent times, several of the NFOs have been sectoral funds and thematic funds. In this article, we discuss whether such funds fit into your investment portfolio.

Sector funds are positioned to bet on specific sectors such as the banking sector and chemicals sector. Thematic funds are positioned to take a bet on multiple sectors at the same time. Defense, for instance, has been a popular theme in recent times. This theme constitutes capital goods, automobile and chemicals sectors. Sectoral and thematic funds are structured as active funds or passive funds (either index funds or ETFs).

We explore how these funds fit into your portfolio from a core-satellite framework. The core portfolio is a goal-based portfolio whereas the satellite portfolio is a trading portfolio. You can also look at the core portfolio as a bet primarily on market movements and the satellite portfolio as a bet to beat the market. Beating the market means you are expecting to earn alpha- returns greater than a benchmark index. You can do this in two ways. One, trade actively in the market. So, market timing becomes the primary factor in generating alpha. Alternatively, you can bet on sectors through sector funds. While betting on sectors is much better than betting on individual stocks, you must have a view on which sector is likely to do well in the near term. Typically, sector funds and thematic funds are launched in response to market interest, not necessarily in anticipation of sectors doing well in the future. You could instead look at funds that are focused on mid-cap and small-cap stocks. Such funds are likely to rotate across sectors based on fund managers’ forecast of near-term sector movements.

You must be mindful that mid-cap (small-cap) active funds do not invest only in mid-cap (small-cap) stocks. SEBI regulation allows these funds to invest 35% outside of their chosen benchmark. If you want pure exposure to mid-cap (small-cap) stocks, you must buy units of mid-cap (small-cap) index fund or mid-cap ETF. It is important that you have an outlook on the mid-cap or small-cap index. For instance, you must have a view that mid-caps are likely to outperform other styles (large-cap and small-cap) in the near term. That requires understanding of technical analysis. You can also subscribe to fee-based technical analysis research to enable you to bet on sectors or themes.

(The author offers training programmes for individuals to manage their personal investments)