What is the difference between Sectoral and Thematic funds?

What are Sectoral and Thematic funds?

Sectoral  and Thematic Funds are open-ended equity mutual fund schemes investing in a single sector or varied sectors anchored around a core theme. 

Thematic funds allow investors to invest in stocks linked to specific ideas while sectoral funds are concentrated investment opportunities to invest in specific sectors such as IT, Pharma, Auto, FMCG etc that have an excellent growth potential.

Both Sectoral  and Thematic funds can invest in companies of all sizes from large-cap to mid-cap to small-cap. Besides, both these funds are also mandated to invest at least 80 percent of their total assets in the respective sector/theme the fund is dedicated to, as per guidelines of market regulator, SEBI. 

The performance of companies in different sectors such as Banking, Pharma, Auto, Metals, FMCG, IT etc  follow their unique and evolving seasonal, cyclical, structural business cycles. Across a given time frame, each sector would perform differently. For instance, it is common knowledge that auto sales take a beating at the end of the calendar year and that most companies see a slew of new launches in the January to March quarter. This is also reflected in the company earnings. Sectoral and thematic mutual funds, both, help investors capitalise on such specific opportunities to grow their investments. 

So, how are sectoral and thematic funds different?

• Investment focus

Sectoral funds are focused on a single sector

Sectoral funds aim to invest predominantly in companies working in a specified sector. The equity exposure is limited to a single sector such as Banking, Pharma, FMCG, IT, Auto, Metals etc.

For instance, the Covid-19 pandemic opened up various opportunities for growth in sectors like pharma and technology. A fund that only invests in companies within the pharmaceutical sector would identify investment opportunities within the sector and seek to cash in on potential high growth returns. 

Similarly, an Infrastructure Sector fund would look to invest in companies that are participating in and benefiting from growth in Indian infrastructure and related activities.

Thematic funds are focussed on multiple sectors anchored around a theme

Thematic mutual funds carry a broader vision in terms of the investable universe and hence, aim to invest predominantly in the companies impacted by a specified theme. Such companies typically belong to more than one sector. Thus the scope and investment objective of a thematic fund is much larger than that of a sectoral fund. 

For example, rural income led demand growth could be a theme which may involve several sectors. When rural incomes increase, then rural demand also increases and that creates demand for products like agri-inputs, two-wheelers, discretionary consumer products, white goods etc. So a thematic fund with focus on rural consumption can invest in all these stocks that look to ride on the rural spending theme.

Similarly, a fund that follows an ESG (Environment, Social, Corporate Governance) theme, would invest in companies that have fared well in terms of environmental, social, and (corporate) governance factors. Such companies could be from multiple sectors (technology, financial services, FMCG, Auto, Metals etc.).

Thematic funds could also include special opportunities funds focusing on companies involved in corporate actions like IPOs, buyback, mergers, demergers, etc. 

So basically, Thematic funds can invest across different sectors and market caps as long as it ties to the theme.

• Asset diversification

Sectoral funds offer minimal diversification 

True to its name, sectoral funds invest in and have exposure to a single sector, say for example, Pharma or IT, or Auto etc. Not surprisingly, such a  scenario offers no diversification opportunities. And, in case the sector does not perform well, there is a potential risk of negative impact as well.

Thematic funds offer relatively more diversification opportunities vs. sectoral funds

Since Thematic funds invest around a core theme, their exposure is spread across a few sectors. Thus, compared to sectoral funds, thematic funds have a relatively lower risk of negative impact when an individual sector under-performs. 

For instance, let's take a fund that has exports as its theme - It invests in a host of companies that belong to different industries, from Textiles, to Chemical to Engineering to Others. So, even if companies from one sector don't perform well at a given point in time, other sectors will protect the portfolio from failing to generate positive returns.

• Risk Profile

Sector funds offer high risk and high growth return potential

Since these funds focus majorly on one sector, they carry a high-risk possibility with them, but also come with high-return potential, in case the sector performs well due to some favourable condition. These funds are usually suited for investors with a very high risk appetite.

Thematic funds have a slightly less aggressive risk profile versus Sectoral funds

Thematic fund invests across a few sectors based on a common theme. Thus, they offer a slightly more diversified portfolio to the investor than the sector fund. While Thematic funds too carry a very high-risk possibility, they are considered less risky than the Sector funds due to the relative diversification on offer.

How are Sectoral and Thematic Funds taxed?

As per the Income Tax Act, Thematic and Sectoral funds are like any other equity-oriented funds and are subject to taxation as follows:

• For investments under 12 months, the gains are taxed as short-term capital gains at a tax rate of 15 percent (plus applicable surcharge and cess). 

•  For investments more than 12 months, the gains are taxed as long-term capital gains at 10 percent (plus applicable surcharge and cess). 

• As per the Income Tax laws, an exemption of up to INR 1 lakh is provided every year in respect of long term capital gains from equity shares and equity oriented mutual funds.

Who should invest in Sectoral and Thematic funds? 

• Investors with an aggressive risk appetite

• Active and tactical investors who have a high degree of market knowledge, and understand sector nuances.

• Investors with a long term horizon.

It is prudent to limit exposure to sectoral and thematic funds to 10 percent.

As per the latest data from AMFI (association of mutual funds in India), there are 107 Thematic and Sector funds holding INR 1.09 Lac Crore of Assets under management (AuM). About 10 percent of the total investment in Equity funds at present is in thematic and sectoral funds.

Sectoral funds are broadly spread across eight categories including Natural resources funds, Real estate funds, Financial funds, Communication funds, Precious metal funds, Healthcare funds, Utility funds and Technology funds

Some of the popular themes that funds invest in include India opportunities fund, Special situation fund, Special opportunities fund, Ethical fund, Transportation and logistic fund, Export and services fund, Manufacturing fund and COMMA fund (investing in commodities).