How is thematic investing different from sectoral investing?

Sectoral Funds

Picture a magnifying glass poised over a specific industry, making seemingly distant observations clearer and more comprehensible. In essence, sectoral funds focus on specific sectors like healthcare, finance, pharma, or FMCG. For example, healthcare funds focus primarily on investments towards companies in the healthcare domain. Similarly, auto funds only concentrate on investing in companies in the automotive domain.

There are three main reasons why investors choose sectoral funds -

• Sectoral insight Investors with key insights regarding a certain sector utilise that knowledge to choose individual stocks or sector-focused funds. A formidable comprehension of a specific industry helps individuals make informed decisions, which improves outcomes.
• Cyclical trends Some industries are very sensitive to business cycles. Property values rise in prosperous times, but declines can be severe. Comparably, consumer discretionary expenditure, which affects the car and tourism sectors, increases during prosperous times but decreases during recessions. Seasoned investors tend to ‘time the market’ by actively investing in expansion phases. Cyclical trends help investors garner a reasonably predictive outlook at investments.
• Hedging Risk Investors reduce the risks inherent in specific companies while continuing to benefit from sectoral developments by diversifying within a domain.

Diversification, in this case, can be a double-edged sword. While investors can benefit from overall sectoral gains, regardless of how individual companies perform, negative impacts on the industry as a whole can harm portfolio growth.

Furthermore, sectoral investing can have higher expense ratios. Higher management fees directly impact on the investor's bottom line and are subject to payment even if one incurs a loss.

Thematic funds

Thematic investments focus on investing in companies encapsulated in a theme or trend. For example, funds focused on infrastructure will primarily invest in companies in steel, cement, machine manufacturing, construction and allied domains. As a result of investing in thematic funds, investors can potentially protect their portfolio if a specific sector performs badly, as other sectors will cushion the fall.

There are three main reasons why investors choose thematic funds -

• Capitalising on early growth Thematic funds provide prospects that surpass standard indexes by leveraging new themes with strong growth potential. Consider it an early mover's advantage, by targeting emerging trends, thematic investing helps investors capture nascent industries positioned for exponential growth.
• Diversification Thematic funds provide greater diversity than standard sector-based strategies by frequently investing in various sectors and territories. This can improve investment resilience and reduce the danger of concentration.
• Long-term sustenance Thematic investments can be considered a forward-think approach, such that themes like automation, renewable energy, and infrastructure are examples of trends that have the ability to grow steadily over time despite short-term economic swings. Investors align their portfolios to these themes to benefit from future developments that can potentially outperform conventional investments.

However, by their very nature, emerging themes and enterprises lack the same track record as more established sectors. Investors must therefore have a greater risk tolerance because this equates to more volatility and uncertainty. Nevertheless, Thematic funds are considered relatively less risky than sectoral funds due to increased diversification.

Furthermore, the success of thematic investing heavily relies on an accurate understanding of the market and the ability to identify optimal entry and exit points for their investment. This necessitates the need for active management and potentially high expense ratios.

Conclusion

In 2023, sectoral and thematic assets under management increased by 30% according to AMFI, displaying a continued growth in investor interest. Both investment schemes hold a great deal of potential for long-term growth. While sectoral funds concentrate on established businesses navigating cyclical patterns, thematic funds surf the waves of emergent trends. However, your long-term goals, preferred return profile, and risk tolerance will determine which option is best for you.