Indian investors in sectoral or thematic mutual funds face risks like high concentration, market cyclicality, sharp volatility, and regulatory changes. These funds depend heavily on industry performance and global trends, often leading to long underperformance periods. Suitable only for experienced, high-risk investors, they should complement—not replace—diversified core portfolios.
Mutual funds in India are broadly divided into diversified equity funds (investing across industries) and specialized funds such as sectoral and thematic funds.
- Sectoral funds → Focus on one industry or sector (e.g., banking, IT, pharma, FMCG, infrastructure, energy).
- Thematic funds → Broader than sectoral; invest in multiple sectors but linked by a theme (e.g., consumption, ESG, manufacturing, digital India, EVs).
They aim to capture high growth potential in specific areas. However, because they are concentrated investments, they carry higher risk compared to diversified funds.
2. Key Risks of Investing in Sectoral/Thematic Funds
Here are the major risks Indian investors should consider:
2.1 Concentration Risk
- Diversified equity funds spread money across many industries.
- Sectoral/thematic funds restrict investment to one sector or theme, making them highly vulnerable to downturns in that sector.
- Example: Pharma funds did well during COVID-19, but later underperformed when global demand normalized.
Implication: If the chosen sector struggles, the entire portfolio suffers.
2.2 Cyclical Risk
- Many industries are cyclical, meaning their performance depends on economic cycles.
- Example: Banking and infrastructure do well in expansion phases but struggle in downturns.
- IT depends on global outsourcing demand; auto depends on consumer spending and credit availability.
Implication: Sectoral funds can swing sharply with business cycles, making them risky for long-term stability.
2.3 Volatility Risk
- Because they lack diversification, sectoral funds show higher volatility than diversified funds.
- Example: IT sector funds may rise 30% in a good year but fall 25% in a global slowdown.
Implication: NAV fluctuations are sharper, testing investor patience.
2.4 Timing Risk
- Success in sectoral/thematic funds depends on entering at the right time and exiting before the cycle turns down.
- Retail investors often join after strong past performance, only to face corrections.
- Example: Infrastructure funds in 2007–08 saw massive inflows, but then underperformed for nearly a decade.
Implication: Timing mistakes can lead to wealth destruction.
2.5 Regulatory & Policy Risk
- Certain sectors are highly dependent on government regulations.
- Example: Telecom (spectrum auctions, AGR dues), power (tariff rules), banking (RBI regulations), pharmaceuticals (US FDA approvals).
- Sudden policy changes can hit sector growth.
Implication: Returns are vulnerable to external decisions beyond market forces.
2.6 Global Dependency Risk
- Many Indian industries depend on global markets.
- Example: IT exports rely on US/Europe demand; pharma relies on USFDA approvals; metals depend on global commodity prices.
- A global slowdown can directly hit Indian sector funds.
Implication: Even if the Indian economy grows, global downturns may drag sector-specific funds.
2.7 Liquidity Risk
- Sectoral funds often have limited investor participation compared to large diversified funds.
- In downturns, redemption pressures may cause higher volatility.
Implication: Exit during poor cycles can be difficult without taking losses.
2.8 Misjudging Themes
- Thematic funds may chase trendy ideas like electric vehicles, digital India, or ESG.
- These themes may not deliver long-term profitability if execution or adoption is slower than expected.
- Example: Renewable energy funds may underperform if adoption faces regulatory or cost hurdles.
Implication: Overhyped themes can disappoint investors.
2.9 Longer Underperformance Periods
- Diversified equity funds usually recover as some sectors offset others.
- But sectoral funds may remain in long phases of underperformance.
- Example: PSU sector funds struggled for years despite market rallies elsewhere.
Implication: Patience needed may exceed investor tolerance.
2.10 Fund Manager Risk
- Success of a sectoral fund depends heavily on the manager’s expertise in that sector.
- Misjudgment in stock selection or overexposure to weak companies magnifies losses.
Implication: Manager skill is more critical here than in diversified funds.
3. Case Studies: Indian Sectoral/Thematic Fund Performance
Case 1: Infrastructure Funds (2007–2020)
- Boomed during pre-2008 growth cycle.
- Post-2008, infrastructure projects slowed, NPAs rose, sector lagged.
- Investors who entered in 2007–08 faced over a decade of underperformance.
Case 2: Pharma Funds (2015–2023)
- Performed well during COVID due to vaccine/export demand.
- Later underperformed when USFDA issues, price pressures, and patent expiries hit.
Case 3: IT Funds (2000–2025)
- Dot-com boom → Huge rally.
- Post-bubble burst → Multi-year correction.
- Again strong from 2020 due to digital demand, but volatility remains.
These examples highlight how sector cycles determine returns.
4. Risks vs Opportunities: A Balanced View
While risks are high, sectoral/thematic funds can be useful if:
- Investor has strong conviction about sector growth.
- Used as satellite allocation (10–15% of portfolio).
- Investor can monitor and exit at the right time.
Example:
- A thematic fund focusing on EV and renewable energy may benefit from India’s long-term push towards green energy.
- But adoption pace, technology changes, and global oil prices remain risks.
5. Investor Suitability: Who Should Invest?
Sectoral/thematic funds are suitable for:
- Experienced investors who understand sector cycles.
- Those who can monitor markets closely.
- Investors with high risk appetite.
- Investors looking for tactical bets, not core allocation.
They are not suitable for:
- Beginners in mutual funds.
- Conservative or retirement-focused investors.
- Those seeking steady, long-term compounding.
6. How to Manage Risks if Investing
- Limit Exposure → Allocate maximum 10–15% of equity portfolio.
- Diversify → Combine with diversified funds (large-cap, flexi-cap).
- Entry Strategy → Use SIP/STP instead of lump sum to average cost.
- Exit Discipline → Redeem when sector cycle matures, don’t hold blindly.
- Research Thoroughly → Study government policies, global trends, competition.
- Choose Themes Carefully → Prefer structural, long-term themes like consumption, digital transformation, ESG, manufacturing.
7. Taxation Risk
- Sectoral/thematic funds are equity-oriented if >65% in equities.
- Taxation: STCG (≤12 months) 15%, LTCG (>12 months) 10% above ₹1 lakh.
- High volatility means frequent churning, which increases short-term tax burden.
8. Recent Trends in India (2023–2025)
- Popular thematic launches: Digital India, Manufacturing, EV, Artificial Intelligence, ESG, Defense.
- Investors flocking to sectors linked to government schemes (PLI, Make in India, green energy).
- AMFI data shows rising inflows, but also warnings from advisors that sector funds shouldn’t replace core diversified holdings.
9. Future Outlook
- Sectors like EV, renewable energy, defense, AI, consumption will continue to attract investors.
- However, regulatory hurdles, global competition, and technological shifts can disrupt growth.
- Indian investors must balance enthusiasm with caution, treating these funds as high-risk, high-reward bets.
10. Conclusion
Sectoral and thematic mutual funds in India offer opportunities to capitalize on high-growth industries and emerging trends, but they come with significant risks: concentration, cyclicality, volatility, timing, regulation, global dependency, liquidity, and misjudged themes.
They should never form the core portfolio, but can be a tactical addition (10–15% allocation) for investors with high risk appetite, sector knowledge, and monitoring ability. Beginners and conservative investors are better off with diversified funds.
In summary:
- High returns possible, but so are long phases of underperformance.
- Best used for short-to-medium tactical plays, not long-term compounding.
- Careful entry, diversification, and timely exit are essential.
