Pros and cons of investing in sectoral and thematic funds

Question: My family members and I have been investing in mutual funds.

- HP Ranina

Many wealth managers are advising us to invest in sectoral and thematic funds. Can you please throw some light on what these funds are?ANSWER: Sectoral and thematic funds are equity mutual funds that follow a specific investment strategy. Sectoral funds invest primarily in companies belonging to a sector of the economy or a specific industry such as banks, cement, chemicals, pharmaceuticals, etc. Thematic mutual funds invest in companies across sectors that are related to a common theme such as public sector companies’ fund.

Sectoral and thematic funds are considered to be risky since they invest in only one sector and, if such sector faces a major downturn, the entire fund suffers substantial losses. Further, such funds face regulatory risks where changes in policy can wipe out a sector's prospects. There is also a risk of technological disruption where a new technology can adversely affect the existing industry.

To earn a reasonable return in sectoral funds, investors need to be advised on the time for entry and exit depending on the performance of the sector during the relevant period.

Most investors are attracted to sectoral funds which have reached the peak of the cycle and suffer losses when the sector slows down and the mutual fund units are sold at a lower price. Most investment analysts advise that not more than 10 to 15 per cent of the portfolio should be allocated to sectoral and thematic funds and investors should be prepared to stay invested for at least five years.