Sectoral and Thematic Mutual Funds

Investing in mutual funds has become increasingly popular among novice and experienced investors. Mutual funds offer a convenient and diversified way to invest in the stock market, providing exposure to various companies and industries. However, with so many different types of mutual funds available, knowing which ones to choose can take time and effort. In this blog post, we will explore two popular types of mutual funds: sectoral and thematic mutual funds. We will delve into the differences and highlight their respective benefits and drawbacks. By the end of this post, you will better understand these types of mutual funds and be better equipped to make informed investment decisions.

What are Sectoral Mutual Funds?

Sectoral funds are mutual funds that invest only in specific sectors, such as Pharma, Construction, FMCG, etc. As per SEBI guidelines, sectoral funds must invest at least 80 per cent of their assets in the specified sectors. The remaining 20 per cent is allocated to other debt or hybrid securities.

Sectoral funds can come in different types, with varying market capitalisations, investment objectives, and sets of securities. These funds can invest in sectors such as natural resources, utilities, real estate, finance, healthcare, technology, communication, refined metals, and sometimes even focus on subcategories such as banking.

The aim of sectoral funds is to provide exposure to certain specific sectors that may otherwise lack investors' attention in terms of market share. These funds are typically meant for active and educated investors who can analyse the macroeconomic situation of multiple sectors.

Sectoral funds can beat the market returns and offer a high-reward ratio. However, investors must note that these funds are riskier than diversified equity funds and must carefully consider their risk appetite and investment objectives before investing in them.

Who Should Invest in a Sectoral Mutual Fund?

Sectoral mutual funds are more suitable for investors who understand the market and the specific sectors they are investing in. These funds require a high level of expertise in analysing the macroeconomic situation and the performance of different sectors. Therefore, experienced investors willing to take risks can invest in sectoral mutual funds.

Investors looking for long-term investments ready to bear heavy market fluctuations can also invest in sectoral mutual funds. These funds are generally recommended for investors with a long-term investment horizon of at least 3-5 years. It is important to note that sectoral mutual funds may not be suitable for risk-averse investors who cannot handle the high-risk level.

List of Best Sectoral Mutual Funds to Invest in 2023

• Sundaram Rural and Consumption Fund (Growth)
• Franklin Build India Fund (Growth)
• DSP BlackRock Natural Resources and New Energy Fund (Growth)
• IDFC Infrastructure Fund (Growth)
• Aditya Birla Sun Life Banking And Financial Services Fund (Growth)

What are Thematic Mutual Funds?

Thematic funds are mutual funds that the fund house that invests in stocks based on a particular theme. These funds invest across sectors that follow a specific theme, including multi-sector, export-oriented, etc. As per SEBI guidelines, these funds must invest at least 80 per cent of their assets in stocks of a particular theme spread across different sectors.

Despite being diversified in terms of the number of stocks and portfolio construction, thematic funds are considered riskier than diversified equity funds or large-cap equity funds. Due to the nature of the fund, these funds have a higher exposure to a particular theme or sector, which can lead to fluctuations in the portfolio during adverse market conditions.

Investors of thematic funds must take at least five years to enter and exit the scheme and allow the funds to perform positively. These funds are more suitable for investors with the moderately high risk-taking ability and are willing to accept fluctuations in the portfolio for the potential of higher returns.

Who Should Invest in a Thematic Mutual Fund?

Thematic mutual funds are suitable for investors with a long-term investment horizon and willing to take on higher risks. These investors should have a thorough understanding of the particular theme in which they are investing and a good knowledge of the relevant sectors. Thematic mutual funds are not suitable for conservative investors who prefer to invest in diversified funds. Investors must research and analyse the fund's performance before making investment decisions. It is also essential to remember that thematic funds are subject to market risks, and investors should be prepared to withstand market fluctuations.

List of Best Thematic Mutual Funds to Invest in 2023

• Tata Ethical Fund
• ICICI Prudential Exports and Services Fund
• ICICI Prudential FMCG Fund
• Nippon India Quant Fund
• SBI Magnum COMMA Fund

Advantages and Disadvantages of Sectoral and Thematic Mutual Funds

Investing in sectoral and thematic mutual funds can offer several advantages to investors. Here are a few:

1. Diversification: By investing in sectoral or thematic mutual funds, investors can gain exposure to a specific industry or theme without purchasing individual stocks. These funds typically invest in a diverse range of companies, which can help spread the risk across the portfolio and provide greater diversification than investing in individual stocks.
2. Potential for higher returns: Investing in sectoral or thematic mutual funds can provide the potential for higher returns than more broadly diversified mutual funds. This is because these funds focus on specific industries or themes that may experience higher growth or have a more significant potential for long-term success.
3. Easy to buy and sell: Investing in mutual funds is generally more convenient and less time-consuming than investing in individual stocks. Mutual funds can be easily bought and sold through a brokerage account, and many funds have low minimum investment requirements.
4. Tax efficiency: Mutual funds are often more tax-efficient than individual stocks because they are structured in a way that allows for tax-efficient trading. It can help investors to minimise their tax liability and potentially increase their after-tax returns.

While there are several advantages to investing in sectoral and thematic mutual funds, there are also some potential disadvantages to consider:

1. Higher Risk: Sectoral and thematic mutual funds are often more volatile than broader mutual funds that invest in various industries or themes. These funds are more concentrated in a particular industry or theme, making them more vulnerable to market fluctuations and industry-specific risks.
2. Higher Fees: Sectoral and thematic mutual funds can have higher fees than broader mutual funds because they require specialised knowledge and expertise to manage. These higher fees can eat into investment returns over time.
3. Market Timing Risk: Market timing risk can influence sectors and thematic mutual funds. Investors may be tempted to time the market by buying and selling these funds based on their expectations for the industry or theme, which can lead to missed opportunities and potentially lower returns.

Types of Sectoral Mutual Funds in India

In India, sectoral funds are mutual funds that invest in a particular sector or industry. Some of the types of sectoral funds in India are:

1. Technology Funds: These funds invest in companies operating in the technology sector, such as software, hardware, and telecommunications.
2. Healthcare Funds: These funds invest in companies operating in the healthcare sector, such as pharmaceuticals, hospitals, and medical equipment manufacturers.
3. Infrastructure Funds: These funds invest in companies operating in the infrastructure sector, such as power, roads, airports, and ports.
4. Banking and Financial Services Funds: These funds invest in companies operating in the banking and financial services sector, such as banks, insurance companies, and brokerage firms.
5. Energy Funds: These funds invest in companies operating in the energy sector, such as oil and gas exploration, production, and distribution companies.
6. FMCG Funds: These funds invest in companies operating in the fast-moving consumer goods sector, such as food and beverage, personal care, and household products.
7. Metal and Mining Funds: These funds invest in companies operating in the metal and mining sector, such as steel, aluminium, copper, and zinc companies.
8. Real Estate Funds: These funds invest in companies operating in the real estate sector, such as real estate developers, housing finance companies, and construction companies.

How to Invest in Sectoral and Thematic Mutual Funds

There are two ways to invest in Sectoral and Thematic funds - offline and online.

If you are not confident in your knowledge, you may choose to invest through a broker, but it may lead to different returns and varied expenses in investment. If you wish to invest independently, you must visit the nearest branch of the AMC of your fund and carry necessary documents such as identity proof, PAN card, KYC documents, cancelled cheques, and passport-size photos.

Alternatively, you can choose to invest online through various investment platforms where you can compare and select from more than 1,000 funds, use SIP Calculator or Lumpsum Calculator to estimate the future value of your investment, and avoid brokerage or commission expenses.

Things to Consider Before Investing in a Sectoral Mutual Fund

When considering investing in sectoral and thematic mutual funds, there are several things to remember. First, it's essential to recognise that these funds are considered highly risky and should not make up a significant portion of an investor's portfolio. Most professionals suggest limiting exposure to these funds to at most 5-10 per cent of your overall portfolio.

Additionally, investors should keep their portfolios diversified across multiple large-cap and mid-cap funds and sectoral and thematic funds. It can spread the risk across the portfolio and minimise the potential impact of any one sector or theme.

Since these funds are heavily influenced by the performance of specific industries or themes, investors should be prepared for fluctuations in both bullish and bearish markets. As a result, investments in sectoral and thematic funds are typically more suitable for active investors with a clear understanding of the market and macroeconomic conditions.

Given their cyclical nature, investors should also carefully consider the timing of their entry and exit into sectoral funds. It's important to note that past performance does not necessarily indicate future success, so investors should carefully evaluate upcoming opportunities before making any investment decisions.

Tax Implications

Sectoral and thematic funds are subject to taxation like other equity-oriented funds as per the Income Tax Act. If an investor holds these funds for less than 12 months, any gains made are taxed as short-term capital gains at a tax rate of 15 per cent, plus applicable surcharge and cess. If an investor holds these funds for over 12 months, any gains made are taxed as long-term capital gains at 10 per cent, plus applicable surcharge and cess.

Moreover, according to Income Tax laws, investors are eligible for an exemption of up to INR 1 lakh yearly for long-term capital gains from equity shares and equity-oriented mutual funds. Hence, investors must consider taxation while investing in sectoral and thematic funds to optimise their returns.