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(Precious) Words of Wisdom : "Only those who are asleep make no mistakes." ~ Ingvar Kamprad

Investing In Thematic or Sectoral Mutual Funds Is Unsafe

As the name suggests, Thematic or Sectoral Mutual Funds invest a significant part — not less than 80% — of the corpus or Assets Under Management (AUM) in a particular theme or sector e.g. Banking Fund, Pharma Fund Technology Fund etc.

Prima facie such 'focussed' funds are a great way to make big money. Actually, it is all about human psychology... what we commonly refer to as the 'herd mentality' (or some sophisticated investors would rather term it as 'momentum').

When lots of money is chasing a select sector, it is bound to appreciate fast. And in this momentum, you get the opportunity to make 'big' and 'quick' money.

However, there is a problem:

Time and again, something or the other will catch the fancy of the market. And then everyone will rush headlong into it. Once upon a time it was Dotcom. Then came Infrastructure and Real-estate. Today, forget about investing, hardly anyone even talks about them. Recently, its been Pharma and FMCG. Tomorrow, they too could be forgotten.

We just don’t know when the market fancy starts or when it will end. It could be months, it could be years. So there are good chances that you may either exit too early and miss the best part of the rally; or you may be too late to exit when all the cream is gone.

In short, its a lottery. If you get the timing right you make a killing. If you get it wrong, you get killed. (Note: Here are some shocking mistakes mutual fund investors often commit.)

thematic-or-sectoral-mutual-funds

Moreover, these theme-based funds defeat the three very basic reasons of investing in mutual funds viz. 
- diversification
- professional expertise
- regular monitoring

Firstly, we are concentrating our portfolio and thereby increasing the risk. Whereas, mutual funds are supposed to be a route to 'diversify' our investment, not concentrate it. This concentration risk makes the thematic or sectoral funds highly unsafe.

Secondly, we are taking a call on the market, as to which sectors will do well and which won't. That's not what our intention is when we entrust our money to a professional fund manager. Ideally we should invest in a diversified fund vis-à-vis a sector fund and leave it to the fund manager's expertise and experience to decide on the potential sectors (in fact, that's precisely his job). As I have often advocated, we aren't smarter than the fund manager.

Thirdly, since we don’t know when the tide will turn, we need to constantly monitor a theme-based portfolio. Again, we had opted for mutual funds because we didn't have the time required to regularly track and update our investments. Because we won't be in a position to devote time, we are likely to get our entry and exit timings completely wrong.

Given all this, thematic or sectoral funds carry much higher risk than the diversified mutual funds. 

As such, it would be prudent to ignore them or at best invest only a small percentage of our corpus in them. [And make sure to follow the '10 Rules on How to Choose the Best Mutual Fund'.]

By the way, do you know Why Mutual Funds Won't Survive On The Planet Mars?

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