Photo: iStock
Photo: iStock

The differences between sector and thematic mutual funds

They are usually launched at a time when fund houses feel that a particular sector or a cluster of sectors is expected to do well in the near- to medium-term future

HDFC Asset Management Co. Ltd, the country’s second-largest fund house, is set to launch its first ever thematic fund called HDFC Housing Opportunities Fund—Series 1 (HHOF). In its 17 years of existence, the fund house was one of the very few among the top 15 fund houses to have stayed away from launching thematic funds, let alone sector funds. We’re not getting into the merits or demerits of these schemes, but let’s understand what sector and thematic fund are.

Although all equity funds—make that, all mutual fund schemes—come with risks (and, of course, with a potential to give returns), there are some equity funds that are higher on the risk-return ladder.

In simple words, these funds can give very high returns, but they also come with very high risk. If the markets fall, their net asset values (NAVs) can fall heavily too. Sector and thematic funds are prime examples of such types of equity funds. But there are important differences between these two.

The difference

We know that diversified equity funds—be they large-cap, mid-cap or a small-cap funds—invest across sectors and companies. Sector funds on the other hand invest in just one, or at best two sectors. These funds are highly focused. The mandate of a sector fund to invest in shares of companies that belong only to the sector for which such a fund is launched.

The fortunes of a sector fund are, therefore, tied to the sector that it tracks. Another example of sector funds would be technology funds. These were launched in 1999-2000 when shares of technology companies did well on the back of the information technology boom.

A thematic fund is a bit more broad-based. It identifies a theme and then invests in sectors and companies that are united by this theme. An infrastructure fund is a good example of these funds. Such funds became quite popular in 2006 and 2007 when shares of companies in sector such as housing, cement, and road building rose.

HHOF is also a thematic fund as it aims to invest in sectors such as banks, cement, steel, and paints; which would benefit from the government’s push towards creating low-cost housing.

How to select?

Thematic and sector funds are highly risky funds and not meant for everyone. They are usually launched at a time when fund houses feel that a particular sector (in the case of sector funds) or a cluster of sectors (in the case of thematic funds) is expected to do well in the near- to medium-term future. That’s how technology funds (launched in 1999-2000 during the I-T boom) and infrastructure funds (launched around 2006-07 during the infrastructure boom) came about.

And the above example also provide a good reason to exercise caution while opting for them. In all of the above cases, a sharp rise was followed by sharp falls. Tying your fortunes to just one theme (of few sectors) or worse, just a handful of sectors could prove risky. In contrast, diversified fund invests across sectors; therefore a fall in some sectors doesn’t impact the fund too much.

However, if the sector that your sector fund tracks falls, the NAV of your fund would fall sharply too. Thematic funds, too, suffer from the same risk.

These types of funds are not meant for everyone. Invest in them only if you understand the sector or the theme very well. You should be able to answer questions such as: what causes the sector or these themes to do well and in what conditions they would won’t do well.

Remember that these are opportunistic funds that don’t merit long-term investment. You need to get your entry and exit timings right to make the most out of them.