Returns from sectoral funds depend on the economic cycle and the entry point. So volatility can be much higher here.

Despite the volatility in the stock markets, retail investors are betting on sectoral and thematic funds. In April, these funds reported new inflows of Rs 3,843 crore, the highest among the nine pure equity mutual fund schemes, data from the Association of Mutual Funds in India show. Even passive schemes are gaining prominence as they saw net inflows of Rs 15,887 crore in the month, almost at par with net inflows in equity funds at Rs 15,890 crore.

Sectoral funds: Look before you leap

Sectoral funds always carry higher risk because they bet on the performance of a single sector, unlike equity diversified funds. These funds are cyclical and can go through multiple ups and downs. In the past, many times a few sectors have done well and the same sectors got affected when the scenario changed. As investing is all about the additional risk one takes to generate additional returns, one must know the risk factors and the return potential. Returns from sectoral funds could be higher in the short run because most of the themes go through a cycle. However, these funds lack consistency over the long term.

Harshad Chetanwala, co-founder, of MyWealthGrowth.com, says the risk in sectoral or thematic funds is high as they invest in a theme or sector and their portfolio can be highly concentrated. “The key to investing in sectoral funds is to have good visibility of the sectors and its prospects. Historically, many investors had invested in sectoral funds by merely looking at their returns and this is not the best approach,” he says.

Ideally, Chetanwala says, investing in equity diversified funds works better for investors as they rely on professional fund managers to decide on sector allocation and invest accordingly, instead of investing in sectoral or thematic funds. “The volatility can be much higher in sectoral funds compared to equity diversified. You should build your core portfolio through diversified funds and then if you have a surplus to take an additional risk you could look at 5-10% of allocation in these kinds of funds depending on your risk appetite,” he says.

Brijesh Damodaran, managing partner, BellWether Associates LLP, says investors today are looking at opportunities other than the existing plain vanilla ones. “Returns from sectoral funds depend on the economic cycle and the entry point. Investing in an infrastructure theme in 2019 would have delivered a negative return. However, the same investment if done in 2020 would now give a double-digit return,” he says. An investment strategy should be based on core needs and tactical needs and allocation to sectoral/thematic is a tactical call and accordingly, the overall investment strategy should be framed.

Experts say investors have been looking at the short-term performance of some of the sectoral funds such as infrastructure and technology which have given returns in the range of 17 to 28% for one to three years. While certain sectors such as infrastructure and basic materials are likely to do well as the economic recovery picks up steam, investors must be cautious about the uncertainty arising from the geo-political tension, spiraling inflation, and rising interest rates.

Passive funds for diversification

Passively managed funds continue to attract significant investors’ interest. In fact, during the month only one index fund was launched which garnered around Rs 91 crore and most of the investments came in existing funds. Himanshu Srivastava, associate director – Manager Research, Morningstar India, says, “Passively managed funds in recent times have gained prominence among investors, who have started adding these funds in the portfolio from a diversification perspective.”

Since January this year, asset management companies have raised Rs 7,939 crore from 50 new schemes in passive funds including index funds, funds of funds investing overseas, and gold ETFs. Out of this, Rs 7,239 crore was raised through 32 new index funds, indicating that investors are preferring index funds due to market volatility. Index funds are ideal for those investors who look for predictable returns. These funds do not require extensive tracking and the returns mirror the index.