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Sectoral funds: Tread with care


Over the past year, diversified fund categories such as large cap funds and flexi cap funds have delivered tepid or negative returns, in line with the underperformance of the broader market. The Nifty 50 TRI has returned just 0.6 %, the past year. Certain sectoral and thematic funds have, however, managed to buck this trend. For example, some of the top-performing infrastructure funds and consumption funds have fetched 1-year returns of 6-11% and 7-12%, respectively. While the current market correction may offer a good opportunity to invest, equity investors may be better off treading with caution on sectoral and thematic funds.

Such funds follow a concentrated investment strategy and must invest at least 80% of their corpus in stocks belonging to that specific sector or theme. Investors have the choice of sector funds (those focussed on IT, pharma and banking and financial services, among others) and thematic funds (covering broader themes such as consumption, infrastructure, business cycles, manufacturing and ESG, for instance) which go beyond a particular sector.

Timing entry and exit

The key to making returns from sectoral and thematic funds lies in correctly timing your entry into and exit from these funds. Also, unlike in the case of diversified equity funds, where buying and holding a well-performing fund for the long term can work well, this may not always be so for such funds. “While one needs a longer time frame in these funds like any other equity fund, the right entry and willingness to book profits are necessary actions,” says Vidya Bala, co-founder, Primeinvestor.in.

Given the cyclical nature of most sector and thematic funds, identifying the cycle correctly and investing closer to its start and exiting as it starts to peak, can be key to making returns. Taking the example of infrastructure funds, Bala highlights that such funds can go through long periods of underperformance before they finally deliver and therefore, market timing is important here. But, others such as IT and consumption, both of which are defensive bets can be held over longer periods and still deliver.

 

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Vishal Dhawan, founder & CEO, Plan Ahead Wealth Advisors elaborates on this. “If you believe the IT sector will benefit from the increasing trend towards digitization, IT funds can be held for the long term. Growth in banking reflects the state of economic growth and so banking funds can be considered a longer-term bet as well.”

Rushabh Desai, founder of Rupee With Rushabh Investment Services, says banking stocks form a good part of most flexi cap funds. So, if you hold flexi cap funds, you needn’t go for a banking fund.

Also, note that compared to sectoral funds that have concentrated holdings in one sector, thematic funds—given their broader coverage across a few sectors—can be relatively less concentrated.

Dig deeper, ignore popularity

Another point to keep in mind with sectoral and thematic funds is to understand what exactly they have exposure to. A good example of this is infrastructure funds. While these funds must invest largely in infrastructure stocks, the definition of what constitutes ‘infrastructure’ is not watertight. For example, many of these funds have capital goods, construction material, cement and industrial products among their top sector holdings, while others include automobiles and banking, too.

Bala says, depending on the choice of stocks, infrastructure fund returns can be wide-ranging. On the other hand, IT funds or banking and financial services funds are more likely to have a similar composition—with high duplication in the top 5 stocks, though weights could vary.

Dhawan emphasises that one must also look at the portfolio composition. Since sector and thematic funds can be highly concentrated, it’s worth checking if a few stocks have very high weight in the portfolio. Apart from this, Dhawan recommends steering clear of funds that are trending. “Thematic funds that are very popular are most likely the ones that have fared well recently and so have become expensive, valuation-wise,” he says.

How to use thematic funds

According to Bala, one can use thematic funds to boost their overall portfolio returns. But one must have an understanding of the sector or theme and track the fund regularly. Also, one must be prepared to see sharp downsides in between. She suggests that investors with smaller sized portfolios (say for example, under 10-15 lakh) can ignore thematic funds.

“Too small a percentage allocation won’t make a difference, and a very large one can have an adverse impact,” she says. “Today, capital goods and specific pockets in transportation and logistics are looking good and that makes infrastructure and manufacturing funds a good choice” says Bala.

With the sharp recovery in credit growth, banking and financial services is yet another sector that she thinks is looking attractive, though this has to be viewed in terms of which lending segment the portfolio is exposed to.

Financial advisors that we spoke to suggested capping the exposure to such funds at 5-10% of one’s equity portfolio.



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