SECTORAL AND THEMATIC FUNDS - INVESTMENT UNIVERSE

Do sectoral and thematic funds fit the idea of best investment?

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Take a look at the following mutual fund schemes: (you can click on the names to see detailed reports)

Now, take a look at the following:

What’s the difference in the two lists?

Any guesses!

To understand the difference, take a look at this diagram below.

Investment Universe, Sector, Themes and Stocks

SECTORAL AND THEMATIC FUNDS - INVESTMENT UNIVERSE

The bigger circle represents the entire Investment Universe. The Circles inside represent the sectors. Some sectors together can build a theme. The smaller black circles are the stocks that belong to those sectors or themes.

Based on the fund you choose from one of the lists, you will, knowingly or unknowingly, draw the boundaries for your fund manager.

As is obvious, the funds in List 2 of diversified equity mutual funds have a larger playground, if we can use that word, and the sectoral and thematic funds in List 1 have a restricted one.

With List 1 you are willing to limit your investment to certain sectors / themes. In the case of List 2, you are allowing your fund manager to go almost anywhere in the universe and seek the best opportunities.

Then, why is there still a lure of sectoral and thematic mutual funds? 

One simple answer. You want the maximum returns.

So, this is how it happens. You log on to one of your favourite portals. You filter funds for the best 3 and 5 year returns.

And voila, you get few of the funds with the leash, that is, sectoral and thematic funds.

Since you are here to maximise returns, why should you opt for anything less?

While these funds would perform only when the sector or theme is performing, they could leave you stuck once the sector or theme has fizzled out.

A few years ago Infrastructure theme was hot, today Rural theme seems to be attractive.

When you take on a sectoral and thematic bet, you are essentially playing a pseudo fund manager, taking on a part of her job.  You are deciding the theme/sector that will work for you.

Are you ready for it?

Here’s a note that a sectoral fund investor would send to her fund manager.

Hey Fund Manager,

Please restrict your investment universe to the sector/theme I have selected. Don’t go into Banking when I have selected Pharma and vice versa, howsoever attractive the opportunity might be.

I am putting you on a leash and you don’t dare to run loose. That’s your Lakshman Rekha.

Let there be concentration of holding. Yes, there might be only 10 stocks in that sector and you have to put all my investment in those 10 stocks. Forget the other 500 stocks. You have no choice.

I also know that by giving you this restricted mandate, I am forcing you to buy the stocks from that sector only, even if the investment maths and valuations are not justified. You don’t have a choice, you see.

Make it happen or …I will take my money away.

Best

Your Investor

The truth is, to make sectoral investing work, you need to understand the sector that you are planning to invest in. Not just that you also need to get the timing of investment right. Why? Because if you are entering the sectoral fund when the sector has already delivered, you are likely to be left high and dry.

Read: The 7 Laws of investment diversification

Do you really need a sectoral and thematic fund?

The fact is any broad diversified equity fund manager would like to make use of the best opportunities available, be it any theme or sector.

Take a look at the table below.

Top 10 sectors for Franklin India Prima Plus, Quantum Long Term Equity Fund and ICICI Pru Value Discovery Fund

Sectoral and Thematic Mutual Funds - Good iidea?

Data Source: www.unovest.co

The tables showcases the Top 10 sector holdings for 3 diversified funds. The highlighted cells are those sectors which are also offered as sectoral funds by various fund houses.

As you can see, some of the sectors that you, as an investor, would want to invest are already there in a diversified equity fund. Examples are Banking and Finance, Pharma, Logistics, etc. By investing separately in sectoral funds, you only increase your exposure to those sectors. Why would you do that?

Let me ask you – isn’t sector selection the fund manager’s job? That’s the reason you select a mutual fund so that the fund manager can do the investments for you.

In fact, you wouldn’t believe that several fund managers go bottom up, that is, they evaluate individual businesses as investment opportunities. They don’t start with sectors or themes.

Here’s a note by an investor to a diversified equity fund manager. 

Hey Fund Manager

I have come to understand from my investment advisor that I need to have equity in my portfolio to help me reach my financial goals.

Based on what I understand about equity investing, I need to spend time and effort in researching and understanding various businesses. I also need to understand and be able to apply valuation methodologies to arrive at the right price for a business, hence its stock price.

Now the thing is, even if I had an inclination to do all of the above, I don’t have the time and energy to go through the rigmarole.

And that’s where I need your help.

I am investing in your diversified fund with the mandate to go out and dig investment opportunities across the board.  You have a free hand.

Frankly, I am not a returns chaser. So I will bear with you patiently during periods when things might not be looking too good. You have my trust.

I have one request – please don’t do anything stupid. This money is important to me. It will help me to provide for my kids’s education and my own retirement.

All the best!

Regards

Your Investor

 

What do you think?

Which note are you sending to your fund manager? Do share with me. 

Disclaimer: The fund schemes mentioned in this article are only for illustration and example. They do not mean investment advice. Please consult your investment advisor before making any investments.

14 thoughts on “Do sectoral and thematic funds fit the idea of best investment?”

  1. Hi Vipin

    I have invested 15000 lumpsum in “Birla Sunlife Birla Sun Life Banking And Financial Services Fund” looking at the current rally in Banking sector Mutual Funds.

    What is ur take on this investment. Time horizon is 1-1.5 year approx.

    Thanks

  3. Hi Vipin,
    I have an idea about investing into Sectoral funds by turning into a value investor. Let us consider an example. There are two sectors that are struggling in this booming market, IT and Pharma. These two sectors have traditionally done well in the past but due to one or the other issue their valuations are comparatively cheaper. And these two sectors have some iconic companies as well and I am sure they will come out of the problems in the future.
    So don’t you think it makes sense to invest in these sector funds now so that we may reap the rewards after say 3-5 years?
    I am sure many fund managers of diversified MFs are wary of high valuations of other sector stocks.

    If this strategy can be repeated in different sectors at different times, then Sectoral funds does have their merits.

    • Hi Pradeep,

      I am not really sure of this strategy.

      May be you would also want to test your hypothesis with past data first and then see how accurately can you do that going forward.

      Also why not then pick a company or two in the sectors you are aware of and invest?

      Thanks for the comment.

      • Hi Vipin,
        Any particular reason why you have doubts on this strategy?
        All financial advisors advise investor to buy more when market is down and out. My idea is to apply at sector level via sector fund.
        Also same advisors say various sectors will do well at different point of times, what better time to buy into a sector than when it is down.
        Well, buying into mutual funds will give diversification (again advisors support this) in a sector. So funds are better option than stocks.

        I think banking funds are great example of how they have rebounded after they were so beaten down last year till early this year.
        Anyone who invested in those would have got great returns now.

        • Pradeep, I doubted if I can make this strategy work for myself. I give my money to the fund manager after due consideration and let her to the job.
          For you, I mentioned that you should test it for yourself. Hope that clarifies. Thanks

          • Hi Vipin,

            Pradeep has raised interesting point.
            One potential reason to invest in sector could be: Some businesses are hard to understand. Example is Pharma. We know Pharma as a sector will do well overtime due to favorable tailwinds like population is growing old, life style diseases, etc. But is hard to zeroed on one or two companies which can get big share of incremental growth.

            I think it makes perfect sense to invest at Sector level where competitive intensity among players. Pharma fits the bill.

  4. Hi Vipin

    I have one question:

    Lets say I started investing in 1 Mutual with Rs. 5000/month keeping a time horizon of 15 years. But after say 5 years, (my investment becomes 3 Lakh aftre 5 years), I find that the fund is not performing well, e.g. as compare to its peers, or change in Market trends (other category fund performing well ), etc.

    Now as a SIP investor what possible approaches, I can take? I am asking this as fund value invested (3 lakh) is pretty high now, so re-investing via SIP will not make sense, and on the other hand if market is high than Lumpsum also will not make sense. Please suggest?

    • Hi, suppose you had not wanted to change the fund. In that case, your money would still be in an equity fund, despite the high market, in your view. So, what difference would it make if you shift from one equity fund to another?
      Do also help me understand how do you determine that markets are high. I have not been to learn this so far. Thank you.

  5. Hi Vipin,

    Your articles are different from the crowd and I enjoy reading them.
    Do you consider the PPFAs fund worth investing for a long term. It’s performance till now is not more than decent and of late it is below par. As you have taken PPFAs fund as an example, I thought of asking you the question, though irrelevant to this article.
    Regards,

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