Sectoral and thematic index funds return up to 22% in 6 months: What retail investors must know before taking the plunge

With benchmark indices delivering muted returns over the past few years, many investors are looking beyond broad-market index funds for better opportunities. Passive sectoral and thematic funds – tracking banks, metals, energy, chemicals, defence, capital markets and more – have emerged as a popular alternative and are attracting attention despite their higher concentration risk.

What are passive sectoral or thematic funds?

Passive sectoral or thematic funds are index funds or ETFs that replicate the performance of a sector- or theme-specific index. With base expense ratios ranging from about 0.14% to 0.50%, they offer a relatively low-cost way to gain exposure to specific sectors or investment themes.

"If you want exposure to a particular sector but don't want to take fund manager risk, sectoral ETFs and index funds are a good way to do it," said Anubhav Srivastava, partner and fund manager at Infinity Alternatives.

Passive sectoral indices outshine broader market

Source: NSE Indices. Returns are the Total Return Index (TRI), which includes dividends.

Key risks to consider before investing in passive sectoral or thematic funds:

Understand the index methodology: Most sectoral indices are market-cap weighted, allowing one or two stocks to dominate the portfolio. So before investing, it becomes crucial to understand how the underlying index is constructed.

High stock concentration: Many sectoral and thematic indices are heavily concentrated. For instance, as of 30 June 2026, Hindustan Aeronautics and Bharat Electronics together accounted for nearly 40% of the Nifty India Defence index.

Limited diversification: These indices usually hold a small number of stocks. For example, Nifty IT has 10 constituents; Nifty Realty and Nifty Private Bank have 10 each; Nifty Bank has 14; Nifty Auto and Nifty Metal have 15 each; and Nifty India Defence holds 19 stocks.

Sector and timing risk: Sectoral and thematic funds are cyclical. Entering after a sector has already rallied can expose investors to sharp corrections

Avoid investing based on FOMO: New fund offers (NFOs) are often launched when a sector is already popular, and valuations may be stretched.

Check tracking efficiency: Before investing, look at a fund's tracking error and tracking difference to assess how closely it mirrors its benchmark. If you are opting for newer fund houses, it may be prudent to evaluate their execution over a few years before investing your hard-earned money.

How much should you allocate in your portfolio?

Anish Teli, managing partner at QED Capital Advisors, said these funds should be treated as tactical allocations rather than core holdings and recommends limiting exposure to 15-20% of the overall portfolio.

"Investors should avoid spreading this allocation across too many themes, as it can dilute the impact of these funds on the overall portfolio."

Still, these funds are not suitable for everyone. They are best suited for investors with a higher risk appetite who understand sector cycles and can time their entry and exit. For everyone else, experts say diversified equity funds remain the better option, leaving sector allocation decisions to professional fund managers.