Sectoral and Thematic Equity Funds: Should you Invest or Skip?

So, should you jump in? Well, sector funds aren’t for the faint-hearted. They are equity mutual funds, they carry high risk but also offer high rewards if played right.

Jun 2025 - 4 mins read

Sector funds come with a high degree of risk and should be used for satellite allocation.

Imagine stepping into the stock market like entering a bustling bazaar, where each shop represents a different sector-technology, banking, real estate, healthcare, and more. Some stalls are booming, while others are struggling. Now, what if you could bet all your money on just one shop, hoping it flourishes? That’s essentially what sector funds do—they invest entirely in one specific industry.

But here’s the catch: markets are unpredictable, and no single sector leads the pack every year. Just because tech stocks soared last year doesn’t mean they’ll repeat the feat this time. Investing in sector funds is like riding a rollercoaster—it’s thrilling but demands precise timing to avoid a steep drop.

So, should you jump in? Well, sector funds aren’t for the faint-hearted. They are equity mutual funds, they carry high risk but also offer high rewards if played right. Experts suggest they should only make up a small portion of your investment portfolio—just enough to add some excitement, without risking too much.

Sector vs. Thematic Mutual Funds

Let’s break it down further. How do sector funds differ from thematic funds, and what risks should you watch out for?

As of March 2025, mutual funds offer 1,760 schemes spanning across different categories like equity, hybrid, debt, passives and more. Choosing the right scheme from each of these categories can seem like a tall order.

One easy filter you can apply is to check if your risk profile is in sync with the scheme’s risk profile. Within equity mutual funds, sector and thematic funds is one such sub category which comes with a high degree of risk as compared to diversified categories like Flexi Cap or Multi Cap.

While sector and thematic funds are clubbed in one category, they are designed differently in terms of their investment strategy. Let’s understand how they differ.

Understanding The Investment Strategy of Sector vs. Thematic Equity Mutual Funds

As the name suggests, sector funds invest in one particular sector – it could be IT, FMCG, Automobile, Banks, Real Estate and so on. Some sector funds also allow you to invest in themes/sectors available in international markets – FAANG, Energy, etc. These funds invest only in one specific sector at all times; they can’t change the allocation to another sector.

On the other hand, thematic funds are much more broad based in their investment flexibility. A theme like healthcare will encompass not only pharma companies but also include ancillary themes associated with the sector like hospitals, medical devices, clinical trials, outsourcing, telemedicine, medical tourism, health insurance and medical equipment, among others. Thus, we can see that a thematic fund has a relatively more diversified portfolio as compared to a sector fund. Thus, on the risk-reward metric, sector fund is much more riskier as compared to thematic fund.

How Much Should You Allocate?

Ideally, you may have 5-10% of your investment portfolio allocated to sector and thematic funds, which forms a part of your satellite portfolio. What are the risks involved? Why should you have a higher risk tolerance while investing in this category?

If you look at the historical data, no single sector is the top performer each year. Thus, if you are investing in a sector fund by looking at the past returns, you may not get the same returns in future. There will be some or the other sector that may outperform each year.

Real-World Example: BSE IT Index

Let’s take the example of BSE IT Index.

	BSE IT Index
Year	Closing	Return
2020	24,248
2021	37,844	56%
2022	28,672	-24%
2023	36,011	26%
2024	43,188	20%
2025	33,706	-22%

Source: BSE

The BSE IT Index was up by 56% in CY 2020. In 2022, it fell by -24%. Investors who would have invested at the beginning of 2022 looking at the 2021 returns would not have a smooth ride. In 2024, the Index was up 20% but in 2025, the index is down -22% so far till April 21.

Key Takeaways

Within the category of equity mutual funds, investing in sector funds is a high-risk high-reward game and you have to get the time of entry and exit right in such funds. Experts suggest that one can take exposure to a particular sector when everyone else is ignoring it – a contra strategy. One approach you can adopt while investing in a theme/sector is to figure out if the theme is structural or cyclical.

Investing in sector funds can be fraught with risk, especially when you enter after the sector has already outperformed the broader market. It’s better to avoid investing based on rear view mirror; based on the recent past performance as it may not sustain. Thus, it is essential to consult your financial advisor or mutual fund distributor to understand how these funds fit into your portfolio.

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