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Sectoral / Thematic
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|Till Date CAGR|
The best performing mutual funds to invest in 2021
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Sectoral and thematic mutual funds are open-ended mutual funds investing at least 80% of the assets in a particular sector or theme. These funds are equity funds as they invest 80% of their assets in equity and equity-related instruments of a particular sector or a theme.
They are very different from diversified equity mutual funds as they concentrate on investing in one particular theme. A sectoral fund, for example, focuses on a particular sector, like the banking fund invests in banking sector stocks. A thematic fund focuses on a specific theme or opportunity. For example, an ethical fund focuses on investing in Shariah-compliant stocks. A thematic fund can have stocks from multiple sectors and can be slightly more diversified than sectoral funds.
However, sectoral and thematic mutual funds are more seasonal or cyclical. The funds give the best returns when that sector is in its growth stage. Any downturn in the sector can affect the fund negatively. Investors should practise caution while investing in sectoral and thematic mutual funds, and timing the exit from these funds is also very important.
Following are the advantages of investing in Sector and Thematic Funds:
Sector and Thematic funds have high growth potential. In other words, if the chosen sector is performing well, the returns can be significant. Suppose the growth prospect of a particular sector or theme is in continual demand. In that case, the investment will be a fruitful one.
Professional fund managers manage sector and Thematic mutual funds. If an investor has confidence in one sector or theme and is unable to choose the companies to invest in, these mutual funds come to their aid. Professional management will help the investor to generate significant returns.
Following are the limitations of investing in Sector and Thematic Funds:
Sector and thematic funds invest in a particular sector or a theme, respectively. Therefore, portfolio diversification is limited to that sector or theme only. The growth potential may generate significant returns. However, a downturn may result in heavy losses. This is purely because of a lack of diversification. Investing in a particular sector is more or less synonymous to putting all eggs in one basket. However, suppose an investor is very confident about a sector or theme’s performance and understands the cyclic movements. In that case, the returns may be significant.
Sectoral and thematic mutual funds are cyclical in nature. Hence, investors who know the sector can invest in it. These funds lack diversification as they invest in a particular sector or theme. Therefore investors who already have a diversified portfolio and are looking at gaining from the potential boom in a specific industry can invest in these funds.
Sector funds are highly volatile and are comparatively riskier than diversified mutual funds. Moreover, the entry and exit in these funds have to be appropriately timed. Hence investors who have a good understanding of risk and knowledge of these funds can consider investing in them.
It is important to note that investors cannot have all their investments in sectoral and thematic mutual funds. Financial experts advise that an investor shouldn’t allocate more than 10% of their portfolio to these funds as it can be quite risky.
It is essential to perform an in-depth analysis of the sector or theme before investing in the funds. From time to time, read about the industry or theme and follow analyst reports. These give a good insight. Furthermore, track the companies to see if they are actually churning good returns.
While investing in a sector or thematic fund, one should have a long investment horizon. In other words, these are pure equity funds and hence highly volatile. Therefore, to overcome the effect of volatility, it is advisable to have an investment duration of at least five years.
Consider investing in a sector or thematic funds only after having a well-diversified investment portfolio. Furthermore, one should limit their exposure in these funds to a maximum of 5% – 10% of their investment portfolio.
Since sectoral and thematic mutual funds are highly volatile investments, one should have a strict stop loss while investing in them. This will help in minimising the losses. In other words, having a stop loss target will help in timing the exit from the investment. If a sector fails to perform, then one should consider exiting their positions. A stop loss at around 15% – 20% levels is a good limit, and one should exit the fund without thinking twice.
Often sector trends are cyclical. Therefore, it is wise to analyse the trend of a sector along with its historical performance. The phase of a sector can be an indicator of its future performance. Since sector and thematic funds are more focused funds, knowing their trends is very important. Though past returns do not guarantee future returns, it is good to analyse them to understand the fund’s performance over different market cycles. Also, look at the potential opportunities ahead for a particular sector or theme.
Several financial ratios help in evaluating sectoral and thematic mutual funds. However, the following are a few of the key financial ratios that help in evaluating these funds:
Alpha measures how well the fund has performed when compared to its benchmark. If the alpha is positive, it means the fund is delivering superior returns than its benchmark. Investors can compare the alpha of two or more funds investing in a similar sector or theme and pick the one with higher alpha.
Standard deviation measures the volatility of the portfolio. In other words, it measures how risky the fund is by measuring how the returns are deviating from the average returns. A high standard deviation of a fund shows that its returns are very volatile, hence is risky.
Beta is a measure of the sensitivity of a sectoral and thematic fund to stock market movements. A fund is very sensitive to market movements if the beta is more than one. A fund is less sensitive if the beta is less than one. However, the fund and market are in tandem if the beta equals one.
The portfolio turnover ratio is a measure of how many times the fund’s portfolio has changed in a year. A lower turnover ratio is considered good. It shows that the fund manager hasn’t churned the portfolio much, keeping the transaction costs and other expenses low.
Sharpe ratio measures the risk-adjusted returns of a sectoral and thematic fund. In other words, it shows whether the returns are due to a superior quality portfolio or the risk undertaken. Therefore, a higher Sharpe ratio is better.
R-squared measures the effect on a fund’s performance due to market movements. It ranges between zero to 100, where 0 shows no correlation to the market, while 100 shows a high correlation.
Sector and thematic mutual funds, like all other funds, have certain expenses attached to them. The expense ratio includes traction costs, fund management fees, marketing and distribution costs, etc. Moreover, these funds also charge an exit load if the investment is withdrawn before one year. Hence investors investing in these funds should check the expense ratio and exit loads and how it will affect their overall return.
Sectoral and thematic mutual funds are taxable like equity mutual funds and hence have short term and long-term capital gains tax. Before completion of one year from the investment date, all capital gains are called short-term capital gains and are taxable at 15%. Whereas all other gains are considered long-term capital gains and are taxable at 10% if the gains are above INR 1 lakh. Investors have to understand how these funds are taxable before investing in them.
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