Riding the wave: Why sectoral and thematic funds are thriving this year

Mumbai: The surge in mutual fund inflows into sectoral and thematic funds continues to gain momentum, driven by strong domestic flows and a series of sector-specific offerings.

These sectoral and thematic funds have attracted about 42% of active mutual fund flows so far this year. In June alone, inflows into these funds reached ₹22,350 crore, accounting for 55% of total active flows, an 18 July research report by Elara Securities said.

Since the beginning of this year, thematic and sectoral funds have attracted ₹70,000 crore in inflows. Manufacturing funds have captured a significant 28% of these inflows, and infrastructure funds 8%. In absolute terms, around ₹19,500 crore has flowed into manufacturing funds and ₹5,900 crore into infrastructure funds.

The overall skew has shifted towards sectoral and thematic funds with greater urgency in Q1FY25, said Mahesh Patil, Chief Investment Officer, Aditya Birla Sun Life AMC. “In Q1FY25 alone themes like manufacturing and infrastructure saw flows that were seen in entire FY24.”

Why are thematic and sectoral funds gaining popularity?

Typically, thematic funds perform well when the economy is strong, benefitting from favourable market conditions and investor optimism. During economic expansion, specific sectors and themes that these funds focus on see heightened growth.

Investors are willing to take risks and invest in targeted strategies that capitalize on emerging trends and opportunities, leading to higher returns for thematic funds.

India's thriving economy has sparked investor interest in thematic and sectoral funds, driving their popularity, said Rahul Singh, chief investment officer - equities at Tata Asset Management.

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For example, growing interest in theme-centric manufacturing funds can be attributed to several factors, including China-plus-one strategy and production-linked incentive schemes, which highlight India's long-term growth potential. Similarly, the energy sector, both traditional and renewable, is gaining momentum due to increased demand driven by factors like data centres.

“So, theme or sector-specific funds have come into focus now because of the fundamental tailwinds for some sectors that were earlier not there 2-3 years back,” Singh explained. Tata Asset Management has launched seven thematic funds in the past four months, and they are already seeing strong traction, he added.

A word of caution

“We believe that in some of the narrow sector themes there has been some euphoric built-up based on past returns. Investors need to be careful with the risks that they are taking to generate additional returns,” Patil of Aditya Birla AMC said.

Ashwini Shami, executive vice president & portfolio manager at OmniScience Capital also believes that there is euphoria in pockets like railways, defence, infrastructure, and power. However, there is also no doubt about the growth opportunities these areas offer, he added.

Certainly, there has been a noticeable uptick in thematic and sectoral funds, with fresh capital shifting away from largecap funds to these funds with more focused investment areas, Shami said.

“The only tricky part is the hefty valuations,” he said. Two-three years ago valuations in these high-growth sectors were subdued, but they have now moved considerably higher, he added.

Abhilash Pagaria, head of Nuvama Alternative and Quantitative Research, said Sebi and Amfi had brought regulations restricting mutual funds to a single scheme per category, be it midcap, smallcap or largecap.

This restriction has prompted mutual funds to capitalize on the robust economy by launching thematic and sector-specific funds. Unlike category-based funds, these thematic and sector-focused funds allow mutual funds to concentrate on specific themes or sectors regardless of their category.

“With fresh capital being deployed at all-time high levels, investors should be discerning and focus on sustainable themes or sectors to avoid potential pitfalls,” he cautioned.

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