Thematic and Sector Funds: Hype vs. Reality - Watch for the Trap

How the landscape has evolved over time

As you can see below, before the onset of COVID-19, these funds were relatively unknown and struggled to gain popularity. However, by June 2024, the landscape had shifted dramatically. Sectoral and thematic funds saw an unprecedented surge, with their monthly inflow reaching a record-breaking ₹22,300 crore, the highest amount ever recorded

The AUM of the sector/thematic has experienced significant growth over the past few years. Starting at 168,660 in December 2022, it surged to 460,921 by January 2025. This remarkable increase represents a growth of approximately 173%.

The Illusion of High Returns: The Hidden Risks of Thematic and Sector Funds

Sectoral and thematic funds are known for their high volatility and unpredictability. While they can sometimes deliver impressive triple-digit absolute returns in certain years, they can also result in negative returns for extended periods. If you were an investor back in the 2000s, you likely recall the excitement surrounding the infrastructure theme. During that time, the Nifty Infrastructure Index saw an astonishing rise, tripling in just 18 months and delivering around 350% abs returns between Jan 2005 and Jan 2008. However, the story took a turn for the worse. After reaching its peak in 2008, the index took a gruelling 15 years to finally regain that same level. Picture the frustration of the investors who, in late 2007, had piled into infrastructure stocks, eagerly anticipating their meteoric rise to continue, only to face years of stagnation and losses.

Dark side of the Sector / Thematic Funds which no one is talking about

At the height of the market frenzy, sectoral and thematic funds became the talk of the town. Investors, eager to ride the wave, poured their money into trending sectors, convinced they had found the next big opportunity.

But as history has often shown, markets move in cycles. The initial excitement soon gave way to cyclical challenges, and many investors fell into the trap of FOMO (fear of missing out). They rushed in when valuations were soaring, only to realize later that they had bought at the peak. When the cycle turned and prices fell, panic set in, leading to hasty exits at a loss.

The table above clearly illustrates how sectoral and thematic indices have experienced significant declines from their 52-week highs, especially when compared to broader market indices. This stark contrast highlights the volatility of sector-specific investments, which often fall harder than the overall market.

Diversified Mutual Funds: A Wise Choice for Long-Term Growth

• Even experienced investors struggled to time the market perfectly, with what seemed like a winning strategy often turning into a costly lesson in chasing trends. The lesson? Investing isn't about following the crowd, but about discipline, patience, and understanding market cycles. Timing sector-specific investments is tricky, and sector performance often rotates unpredictably, making it risky to chase past winners.
• Many investors, especially those who jumped into popular sector and thematic funds, are now facing losses after the recent market sell-off. While the downturn affects the entire market, it's particularly harsh on funds focused on trendy themes with inflated valuations. Unfortunately, many investors have poured money into these funds without fully understanding the risks.
• A diversified mutual fund, on the other hand, provides a more stable and balanced approach, reducing exposure to sector-specific risks. It helps investors avoid the pitfalls of chasing sectors based on past performance while benefiting from long-term growth and minimizing tax implications. In the end, a diversified strategy offers greater financial security and reduces the likelihood of falling into short-term investment traps.