🔥 Sectoral funds are selling like hotcakes!

Welcome to this week’s issue of the Altsights newsletter!

✅ Sensex and Nifty have hit all-time highs (yet again!)
✅ India’s market cap briefly touched $5 trillion
✅ Equity funds saw the highest monthly inflow of ~Rs. 35,000 crore led by the riskiest category

Here's What's in Store for You Today:

• The Big 3️⃣ Numbers

• The Theme of the Season 🔥

  • Understanding Sectoral and Thematic Funds 👨🏻‍🏫

  • The Dark Side of Sectoral/Thematic Funds 🌑

  • Presenting Mid Cap Mutual Funds 📊

• Reader’s Spotlight💡

The Big 3️⃣ Numbers  

The Theme of the Season 🔥

In May 2024, sectoral and thematic funds received their highest-ever monthly inflow of ₹19,200+ crore.

As you can see below, prior to COVID-19, these funds were hardly popular.

So what exactly are sectoral and thematic funds, and why are they selling like hotcakes?

Understanding Sectoral and Thematic Funds 👨🏻‍🏫

Sectoral funds are mutual funds that invest in stocks of companies of a single sector, such as technology, healthcare, or banking. 

So, a technology sector fund will invest in tech companies like TCS, Infosys, Zomato etc.

Similarly, a banking fund will invest in banks like SBI, HDFC etc.

Thematic funds, which are broader than sector funds, invest in stocks of companies that are linked to a specific theme or trend. 

These themes could range from emerging technologies, sustainability, and green energy to demographic trends like ageing populations.

For example: The Aditya Birla Sun Life Digital India Fund invests in companies like HCL, Bharti Airtel and Tech Mahindra that are likely to benefit from digitalisation.

Quick and High Returns 🚀

Investors are drawn to sector and thematic funds primarily due to their potential for delivering high returns over short periods.

In 2023, the Nifty 50 index delivered an impressive 19.42%. But, compared to returns generated by certain sectors/themes like PSU, Infra and Pharma, the Nifty 50’s returns look paltry.

The Dark Side of Sectoral/Thematic Funds 🌑

Sectoral and thematic funds are highly volatile and unpredictable.

Sectors and themes can potentially generate triple-digit annualised returns in some years and negative returns for many years.

If you were an investor in the 2000s, you’d remember the rage around the infrastructure theme.

The Nifty Infrastructure Index tripled within 18 months delivering ~200% annualised returns between June 2006 and Jan 2008.

But then came the scary part - the Nifty Infrastructure Index took 15 long years to regain the peak level it attained in 2008.

Imagine the plight of the investors who piled into infrastructure stocks in late 2007 expecting their meteoric rise to continue.

This is not the only time a sector/theme has caused heartburn to investors.

• The Nifty Pharma Index which last peaked in 2015 is still below that level even after 9 years now.

• The US Tech Index (AKA Nasdaq) which attained peak euphoria in 2000 took 15 years to breach its 2000 level.

The peaking of sectors/themes have the following classical symptoms:

• Absurdly high past returns

• Sudden spike in social media chatter

• Existing investors start pouring money into them

• New investors join the market just to invest in them

History is filled with many such examples. In investing, you don’t challenge historical precedents - you only respect them.

But My Risk Tolerance is High 📈 

I am sure it is!

But why would you want to gamble your money away? What if there was a mutual fund category that beat sectoral and thematic funds over the long term?

Would you still chase the high-return dream of sectoral and thematic funds that can easily turn into a nightmare?

If you said no, keep reading.

Presenting Mid Cap Mutual Funds 📊

I have often come across investors who say that they have high-risk tolerance. In most cases, they don’t but that’s a different discussion.

If you believe that you have a high-risk tolerance and a very long investment horizon, mid-cap mutual funds can be your pick.

Mid-cap mutual funds have beaten the most popular sectoral/thematic mutual funds in the last 8 years.

You can see the journey of ₹100 invested in mid-cap and most popular sectoral/thematic mutual funds from 2015 to 2023:

Mid-cap mutual funds are diversified across sectors and themes.

So, mid-cap mutual funds can shift gears and over time deliver better performance than sectors/themes that tend to go out of favour after brief periods of popularity.

While mid-cap funds will not outperform each theme each year, they are likely to outperform most sectors and themes over fairly long periods - a better bet than selecting the best sectors/themes every year!

Note - Mid-cap funds are risky too. But they are less risky than sectoral/thematic funds which is why, in my view, mid cap funds should be preferred.

Not Investment Advice ❌

This newsletter is not a recommendation to invest every penny in mid-cap funds. Nor is it to avoid every sectoral/thematic fund you come across.

The recent euphoria in sectoral/thematic funds caught my attention.

As someone who has seen markets/sectors/themes over many cycles, I sensed the need to warn you.

But, I could be completely wrong. The sectoral/thematic euphoria can go on for a while. But it can’t continue forever.

It is important to stick to the basics during such times. Stay level-headed and invest in a diversified investment portfolio that will help you reliably achieve your financial goals.

If you must invest in these risky funds, just don’t go all in.

Reader’s Spotlight💡

Last week, Sukruti from Bangalore asked::

Like Sukruti, are you too curious about personal finance and investing?

I’d love to hear from you!

Simply reply to this email with your question. Each week, I'll select the most insightful question and answer it for everyone’s benefit.

So, go ahead and ask. I can't wait to engage in meaningful conversations!

Cheers,
Madhu,
Founder, Altcase