Why it does not make sense to invest in thematic/sectoral mutual funds!

Published: November 5, 2022 at 6:00 am

Since there is no limit on the number of sectoral or thematic mutual funds an AMC can produce, they do just that! And these have huge fees and are marketed as the next big theme to profit from. But how consistent are they in beating a large cap index? Let us find out.

Note: These are not investment recommendations, and investors should not use the funds listed below as investments. We are trying to point out most thematic funds fail to beat a simple large cap index. This means picking a fund that would outperform in future is impossible. Sectoral funds are generally more volatile than diversified indices or mutual funds. Such funds are suitable only for investors who can appreciate the dynamics of a particular sector or theme and can make tactical (quantitative or qualitative) entries and exit such as this: Do not use SIPs for Small Cap Mutual Funds: Try this instead!

How the funds were selected

We consider every possible 3,4, and 5-year investment window between Jan 2013 and Oct 2022.

We shall define a return outperformance consistency = no of times fund beat index/tot no returns. For example, we have 100 3-year return data points and a fund returned higher than the index in 65 instances. Then return outperformance consistency = 65/100 = 65%.

To qualify as a “consistent performer,” the fund should have a return outperformance consistency of 70% or more. The full details of the study and data for other mutual fund categories can be found here: October 2022 Equity Mutual Fund Performance Screener.

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    • Five years: Among 60 thematic/sectoral funds with over 500 rolling return five-year data points, only 12 quality with a return outperformance consistency of 70% or more.
    • Four years: Among 65 thematic/sectoral funds with more than 500 rolling return four-year data points, only 13 quality with a return outperformance consistency of 70% or more.
    • Three years: Among 64 thematic/sectoral funds with over 500 rolling return three-year data points, only seven have a return outperformance consistency of 70% or more.
    • 3Y and 4Y, and 5Y: only five have a return outperformance consistency of 70% or more.

    The five consistent thematic mutual fund performers

    The following funds have a return outperformance consistency of more than 70%.

    1. Canara Robeco consumer trends fund – direct plan-growth option
    2. Mirae Asset Great Consumer Fund – Direct Plan-Growth
    3. Aditya Birla Sun Life India Gennext Fund – Growth – Direct Plan
    4. Aditya Birla Sun Life Digital India Fund – Growth – Direct Plan

    In summary,  only 5 out of 60 funds consistently outperform a large cap index. While this is not the investment mandate of the funds, the large cap index serves as a benchmark for the retail investor. Why would I invest in such expensive funds if a simple large cap index fund (Sensex/Nifty/Nifty 100) performs better?

    Choosing to invest systematically in thematic funds can be an expensive mistake similar to the situation for small cap funds: Do not use SIPs for Small Cap Mutual Funds: Try this instead! Note that tactical calls are not perfect and can go wrong.

    We, therefore, recommend that investors avoid all thematic or sectoral funds unless they have a good understanding of the investment universe and can make tactical entry or exit calls.

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