Pharma sector funds and schemes focused on the US and technology stocks have been on fire. Is this rally in such themes a trigger for you to jump in? Though it’s tempting to invest in them, they are not as straight-forward as your normal diversified equity funds. Some are more diversified than the others through, but both sector and thematic funds are narrower in their approach.
A sector fund invests in stocks of companies from a particular segment. Examples include schemes focused on FMCG, pharma, banking and so on.
On the other hand, a theme fund can have a diversified portfolio comprising shares of companies operating in many sectors. Infrastructure, energy and dividend yield themes can have stocks across pharma, construction, engineering, capital goods, energy, chemicals and metals among others.
How themes and sectors play out
Thematic funds typically run their course over a slightly longer period of time than sector funds. Sectoral up and down-cycles are typically short-lived compared to those of themes. “Themes are seen as long-term secular trends arising out of changing consumer preference, disruption caused by technology or the way the business is conducted,” says Ravi Kumar TV, founder of Gaining Ground Investment Services.
Indian consumption and the technology sector in the US are some of the long-term themes that have been popular. A sector’s prospects may change due to temporary reasons such as the government’s intervention or some other trigger. For example, the coronavirus pandemic can be a positive trigger for the pharmaceutical sector. The banking sector in India has been very popular and is seen as a proxy to the domestic growth story over the past two decades.
Timing of investments, the key
Even if you get the entry right, sector funds could still face some volatility before they begin their march upwards, as the portfolio could be concentrated with a few top stocks from the segment.
Thematic funds are a bit better off since they invest across multiple sectors. After 2008, while the infrastructure theme was battered, some sub-pockets such as cement showed promise. Schemes with higher weightage to the cement sector did better than pure infrastructure funds that invested more in capital goods and manufacturing companies.
The risk involved
The focus works against you when the sector or the theme goes out of favour. In 2001, the information technology sector went out of favour as the ICE (information technology-communication-entertainment) bubble burst. Schemes focused on the IT sector lost money. According to Value Research, IT sector funds lost 42 per cent and 37 per cent in 2000 and 2001.
A theme can run for much longer. For example, schemes focused on the consumption theme did well over last decade. Even in post-demonetisation times, when the rural India was in much distress, the consumption theme, driven by discretionary consumption, did well.
A timely exit, though, is crucial in both sector and theme funds since the ideas have a definite maturity period.
Can I eliminate fund manager risk?
Yes, you can, but in a limited way. Banking funds are an example. It is a widely followed sector by investors, and is given the highest weight in indices such as the Nifty and Sensex. Seven asset management companies offer Bank ETFs. However, such passively managed products are not available for other sectors. Thematic funds offer more options. There are ETFs that track international equities, consumption, infrastructure and dividend opportunities to choose from.
Should you invest?
Entry and exit are crucial to make money in a sector fund. Sector funds are extremely risky, but can give you great returns. Make sure you have the risk appetite and the knowledge of a particular sector that your fund invests in. If you do not understand the sector or theme, then it’s best to avoid it.
Beware of rosy past returns in a sector fund, if that’s your cue to invest in one. Much of the sector’s performance may already be in the past, which could also mean there’s very little to earn from it in the future.“Only savvy investors should consider investing up to 10 to 15 per cent of their equity allocation in long-term themes, if they understand the themes,” says Ravi Kumar. Otherwise an average investor is better off with diversified equity funds.