Mutual funds: Thematic Vs sectoral funds

The latest Sebi categorisation on mutual funds have streamlined various options helping investors to choose the funds easily. Accordingly, the regulation has also come up with some restrictions on how thematic or sectorial funds be managed by the fund houses. Before judging on whether to invest in these type of funds, let us understand how these funds actually work and thus see to which investors’ it fit.

Thematic funds are mutual funds which invest in companies that are based on a defined theme i.e. a concept that is focused on specific idea. So, these funds could invest sector-agnostic and market-cap agnostic. This depends on the theme - the larger the theme, the diversified the fund would be. For instance, in an infrastructure fund, the composition of portfolio involves across sectors of engineering, cement, metals, oil & gas, banking/finance and telecom just to name the top. This is true with themes like rural and consumption funds that are on avail where the top five sectors consist of banking/finance, automobiles, consumer durables, consumer non-durables and other allied services.

In a sectoral fund however, the portfolio consists of stocks concentrated on that particular sector namely banking & financial services fund or pharma fund where the stocks of these sectors are only picked up.

For instance, a pharma fund would concentrate on stocks across the market capitalisation but stick to only companies dealing in manufacturing, packaging and/or research on pharmaceuticals. Similarly, with the case of an information technology fund which purely invests in companies that provides products and services of IT only.

Of course, the discretion lies with the fund manager whether to stick to only stocks of a specific market cap or have a majority of stocks from a particular market cap. But, despite the market fluctuations and/or macro-economic conditions, the fund continues to invest in that particular sector only. The specificity of the fund objective puts these funds directly into concentration risk.

In terms of the investment style, a thematic fund, due to its broader or obscure nature of the fund description brings in a bit of leeway for the fund manager to indulge in non-core sectors and/or stocks of the theme depending on the market conditions. Accordingly, the fund could avoid a sector which is not doing well or diverse into a sector which could do well or doing well in such market conditions. Thus, despite being focused on a theme, these funds are semi-diversified.

These reasons put a sectorial fund relatively at a higher risk than that of a thematic fund. Despite this, a theme could underperform even during periods of broader good markets as the associated stocks may not do well. Also, both the thematic and sectorial funds are subjected to regulatory and governmental interventions.

For instance, the recent Food and Drug Administration (FDA of the US) observations have led to huge corrections in the stock prices of pharma sector while the new US governments plan to control the prices also has adversely impacted these companies. This lead to a huge underperformance of these stocks and the pharma fund despite roaring performance of both the domestic and overseas stock markets.

Government regulation or focus could also drive stocks of a particular theme in a positive way. For instance, the Indian governments continued thrust towards affordable housing had given fillip to the stocks of housing finance, construction, cement, metals, etc. stocks that are related to housing theme.

As it’s known fact that one can’t time the market, it would be extremely difficult to play out a particular theme or sector from the beginning to the end. So, ideally, a 5 per cent -10 per cent of exposure of portfolio into these funds could help generate a bit of additional alpha for the investor but the catch here is to identify the right theme or sector.

By: K Naresh Kumar
(The author is co-founder of “Wealocity”, a wealth management firm and could be reached at [email protected])