Mutual Fund strategy: Should you invest in sector and thematic funds?

Mutual funds have expanded the investment universe of investors over the years. Not only can investors diversify their portfolios by investing in different asset classes, but they can also get the best from each asset class through a variety of funds. Equity, as an asset class, plays an important role in the wealth building process of investors. There are 10 categories of funds that allow them to invest in different segments of the stock market as well as benefit from different investment philosophies and strategies. While there are choices galore for MF investors, the key is to have a mix of funds in the portfolio that is in line with capacity to take risk, experience of investing in market-linked products and size of the portfolio. 

One category that adds to the mystique surrounding the stock market is sector and thematic funds. These funds usually catch investors’ fancy due to superlative performance from time to time. Since sector funds ride on industry cycles, they have the potential to generate attractive returns if the timing is right, albeit with higher level of volatility. At the same time, they do not provide downside risk protection available in diversified funds. Therefore, someone looking to invest in sector funds must have the ability to withstand periodic bouts of volatility to enhance long-term returns.

Similarly, thematic funds look for trends that are likely to result in out-performance of certain sectors or companies. They focus on structural as well as cyclical factors that play an important role in the economy. Simply put, the key factors are those that can make a difference to business profitability and market values. 

If you are considering to include these funds in your portfolio, here are a few pointers.

Look before you leap
Before investing in a sector fund, you must understand the potential and the attendant risks of investing in a particular sector. If chosen carefully, these funds can play a significant role in allowing you to increase exposure to those sectors that may be under-represented in your portfolio.

Even if you invest in stocks directly, sector funds offer advantages over individual stocks, as fund managers track the industry/sector development for their investors. Since returns of sector funds fluctuate, depending on how the particular sectors they invest in perform, a wrong selection of sector/s can adversely affect your overall portfolio return. 

Like sector funds, thematic funds also carry a high degree of risk. For example, the market may take more time to recognise views of the fund house with regard to a particular theme, which forms the basis of launching a fund. Besides, there can be ambiguity in fund’s definition of a theme. There is also a risk of a fund manager’s style becoming too individualistic, which may be difficult to follow if he decides to leave the fund. However, they are more diversified than sector funds, as they invest in sectors that are likely to benefit from a theme. 

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Follow the right strategy 
You can adopt different strategies to reduce the risk generally associated with such funds. One such strategy is to have a small exposure to three to four sectors/themes. Besides, you must review your portfolio to ensure that you are not invested in a sector/theme that already has a sizeable exposure through other funds. Besides, you should have the capacity to hold these funds for the longer term, if required and must curb the urge to switch from one sector/theme to another

As a thumb rule, if you have a decent exposure to equity funds and are conversant with equity markets, around 10-15% of your portfolio can be invested in sector and thematic funds. The key is to select funds carefully and monitor the progress over the investment period. 

By Hemant Rustagi
(The writer is CEO, Wiseinvest Advisors)

Source: DNA Money