<p>When investors invest in mutual funds, they check whether their objectives agree with the schemes’ objectives. If they are looking at market capitalisation, then they may invest in large-cap, mid-cap, or small-cap funds. If they want tax benefits, they may invest in Equity Linked Savings schemes (ELSS). At times, friends or financial planners may recommend investing in sector funds or thematic funds. If you were in a similar predicament and wondering what they are and how they work, here’s a primer on them:</p>.<p class="CrossHead Rag"><strong>Sector funds vs Thematic funds</strong></p>.<p>As per the SEBI circular issued in October 2017 on the rationalisation and categorisation of mutual fund schemes, an Asset Management Company, or AMC, can launch either a sector fund or a thematic fund. While sector funds focus on sectors like banking, pharma, information technology, FMCG, etc and invest in stocks in one specific sector, thematic funds focus on certain themes and invest in stocks in sectors that are linked to the theme. In short thematic funds invest in many sectors while sector funds invest in one sector only.</p>.<p>For example, a thematic fund having consumption as the theme will invest in sectors like retail, hotels, resorts, restaurants, personal care and automobile. The fund will be betting on the lifestyle of young Indians and how it can construct a portfolio comprising companies that would benefit from the change in spending patterns of young Indians. Similarly, funds having an ESG (Environmental, Social and corporate Governance) theme, will invest in companies that have demonstrated sustainable practices across ESG factors. They also hope to attract investors who invest in such themes as they feel companies embracing an ESG theme will improve the world by reducing carbon footprints. Thematic funds are more diversified than sector funds but less diversified than Diversified funds.</p>.<p>As per SEBI guidelines, these funds have to invest a minimum of 80 per cent of their assets in equity and equity-related instruments in a particular sector or a theme respectively. The assets of both funds are invested in companies across market caps-large, medium and small-cap companies.</p>.<p class="CrossHead Rag"><strong>Risks vs returns</strong></p>.<p>Since both sectoral and thematic funds focus on a sector or a theme there are inherent risks. In addition to the market risk, they are also exposed to concentration risks. For example, a thematic fund that has rural consumption as the theme may expect an increase in demand for products like fertilisers, pesticides, two-wheelers, tractors and consumer durables when rural incomes increase. The theme may not play out if rains fail or there are unseasonal rains income of farmers and non-agriculturists may not go up and the demand for agricultural products fall. The same risk applies to sector funds. </p>.<p>After giving excellent returns during the Covid-19 pandemic, both technology and pharma sector stocks have underperformed in the last year. From a five-year perspective, banking as a sector has been lacklustre. If you believe in a contrarian strategy, you can consider investing in banking sector funds to outperform from now on. After peaking in 2020 and 2021, IT stocks have corrected 30 per cent from the peak and seem to have bottomed out and are ready for a breakout. Pharma stocks also have underperformed post the pandemic. You may consider investing in these sectors for decent returns with a five-year perspective.</p>.<p class="CrossHead Rag"><strong>Taxability</strong></p>.<p>Both the funds are treated as equity funds from the taxation point of view, which means short-term capital gains (STCG) will arise if the investment horizon is less than 12 months and the STCG tax is 15 per cent. Long-term capital gains will arise if the investment is held for more than 12 months and LTCG is 10 per cent on gains above Rs 1,00,000.</p>.<p>A final word of advice. The ideal exposure to sector funds and thematic funds should not be more than 10 to 15 per cent of your portfolio. Both funds are ideal for investors with a high-risk appetite as they focus on a theme or a sector. As an investor, you also need to time the entry and exit from these funds to get maximum returns. Do the due diligence before investing.</p>.<p><em><span class="italic">(The writer is a </span>former banker, CFA and currently teaches at Manipal Academy of Higher Education, Bengaluru)</em></p>
<p>When investors invest in mutual funds, they check whether their objectives agree with the schemes’ objectives. If they are looking at market capitalisation, then they may invest in large-cap, mid-cap, or small-cap funds. If they want tax benefits, they may invest in Equity Linked Savings schemes (ELSS). At times, friends or financial planners may recommend investing in sector funds or thematic funds. If you were in a similar predicament and wondering what they are and how they work, here’s a primer on them:</p>.<p class="CrossHead Rag"><strong>Sector funds vs Thematic funds</strong></p>.<p>As per the SEBI circular issued in October 2017 on the rationalisation and categorisation of mutual fund schemes, an Asset Management Company, or AMC, can launch either a sector fund or a thematic fund. While sector funds focus on sectors like banking, pharma, information technology, FMCG, etc and invest in stocks in one specific sector, thematic funds focus on certain themes and invest in stocks in sectors that are linked to the theme. In short thematic funds invest in many sectors while sector funds invest in one sector only.</p>.<p>For example, a thematic fund having consumption as the theme will invest in sectors like retail, hotels, resorts, restaurants, personal care and automobile. The fund will be betting on the lifestyle of young Indians and how it can construct a portfolio comprising companies that would benefit from the change in spending patterns of young Indians. Similarly, funds having an ESG (Environmental, Social and corporate Governance) theme, will invest in companies that have demonstrated sustainable practices across ESG factors. They also hope to attract investors who invest in such themes as they feel companies embracing an ESG theme will improve the world by reducing carbon footprints. Thematic funds are more diversified than sector funds but less diversified than Diversified funds.</p>.<p>As per SEBI guidelines, these funds have to invest a minimum of 80 per cent of their assets in equity and equity-related instruments in a particular sector or a theme respectively. The assets of both funds are invested in companies across market caps-large, medium and small-cap companies.</p>.<p class="CrossHead Rag"><strong>Risks vs returns</strong></p>.<p>Since both sectoral and thematic funds focus on a sector or a theme there are inherent risks. In addition to the market risk, they are also exposed to concentration risks. For example, a thematic fund that has rural consumption as the theme may expect an increase in demand for products like fertilisers, pesticides, two-wheelers, tractors and consumer durables when rural incomes increase. The theme may not play out if rains fail or there are unseasonal rains income of farmers and non-agriculturists may not go up and the demand for agricultural products fall. The same risk applies to sector funds. </p>.<p>After giving excellent returns during the Covid-19 pandemic, both technology and pharma sector stocks have underperformed in the last year. From a five-year perspective, banking as a sector has been lacklustre. If you believe in a contrarian strategy, you can consider investing in banking sector funds to outperform from now on. After peaking in 2020 and 2021, IT stocks have corrected 30 per cent from the peak and seem to have bottomed out and are ready for a breakout. Pharma stocks also have underperformed post the pandemic. You may consider investing in these sectors for decent returns with a five-year perspective.</p>.<p class="CrossHead Rag"><strong>Taxability</strong></p>.<p>Both the funds are treated as equity funds from the taxation point of view, which means short-term capital gains (STCG) will arise if the investment horizon is less than 12 months and the STCG tax is 15 per cent. Long-term capital gains will arise if the investment is held for more than 12 months and LTCG is 10 per cent on gains above Rs 1,00,000.</p>.<p>A final word of advice. The ideal exposure to sector funds and thematic funds should not be more than 10 to 15 per cent of your portfolio. Both funds are ideal for investors with a high-risk appetite as they focus on a theme or a sector. As an investor, you also need to time the entry and exit from these funds to get maximum returns. Do the due diligence before investing.</p>.<p><em><span class="italic">(The writer is a </span>former banker, CFA and currently teaches at Manipal Academy of Higher Education, Bengaluru)</em></p>
