'First-time or conservative investors should avoid narrow sectoral funds.'
Mutual fund houses continue to widen their product range by launching schemes based on narrow sectoral themes, typically through exchange-traded funds (ETFs).
The latest is Kotak Nifty Chemical ETF, whose new fund offer has opened for subscription.
"By tracking the Nifty Chemical Index, the ETF provides exposure to a basket of leading chemical companies, mitigating single-stock risks, and capturing the sector's broad-based growth potential," says Devender Singhal, fund manager, Kotak Mutual Fund.
"Several other narrow-mandate ETFs track sectors such as real estate, auto, capital markets, and railway public-sector undertakings.
"Funds with narrow sectoral mandates aim to capture cyclical tailwinds and turnaround opportunities while focusing on a relatively limited universe of listed companies operating within a specific sector," says Nirav R Karkera, head of research, Fisdom.
Potential for outsized gains
Narrow sectoral funds can deliver strong returns if the sector experiences a favourable cycle.
"A narrow sectoral fund has the potential to deliver superior returns when the chosen sector enters a growth phase," says S Sridharan, founder and chief executive officer, Wallet Wealth.
"Such funds allow investors to take tactical exposure to capture opportunities arising from structural or cyclical trends within a specific industry," adds Sridharan.
These ETFs also provide a route for taking a contra view on sectors that are currently out of favour.
Being passively managed, they do not carry fund manager risk and have relatively low fees.
High-risk bets
The concentrated nature of these funds, however, amplifies both volatility and downside risk.
"The risks attached to this strategy are higher volatility due to single-sector exposure, concentration risk, and lack of diversification," says Singhal.
"One should have a deep understanding of the chosen sector and carefully consider the market cycle before taking exposure," Singhal adds.
Multiple other risks exist.
"Narrow sectoral funds are exposed to cyclicality, regulatory changes, valuation excesses, and liquidity constraints," says Sridharan.
"Certain sectors may witness prolonged periods of underperformance depending on economic or policy cycles, which can significantly impact overall returns," adds Sridharan.
While ETFs typically invest in larger, liquid stocks, sectoral performance is often driven by a handful of stronger players.
Investors may miss the best performers within the sector.
Timing matters
Returns from narrow sectoral ETFs depend heavily on the investor getting both entry and exit right.
"Timing risk remains one of the key challenges," says Karkera.
"The most common and costly mistakes often stem from entering closer to the top of a cycle and exiting near the bottom, converting notional losses into realised ones," adds Karkera.
"Simply trying to play short bursts of performance through excessive rebalancing and sector rotation may have a depreciating effect on the internal rate of return (IRR) owing to leakages on account of costs, including taxes," says Karkera.
For seasoned investors
These products are best suited for experienced investors.
"Investors with a deep understanding of market cycles, who know the nuances of a particular sector, have a high risk appetite, and are willing to accept high volatility are typically the target audience," says Singhal.
"First-time or conservative investors should avoid narrow sectoral funds," says Sridharan.
"Exposure to such funds should be limited to a maximum of 10 per cent of the overall equity portfolio with a minimum investment horizon of five years to navigate sectoral cycles and realise potential gains," adds Sridharan.
"Prefer a staggered or SIP approach to manage timing risk effectively, as accurately predicting sectoral turning points is inherently difficult," says Sridharan.
Karkera suggests that investors take exposure to sectoral ETFs within the satellite portion of their equity portfolio.
Disclaimer: This article is meant for information purposes only. This article and information do not constitute a distribution, an endorsement, an investment advice, an offer to buy or sell or the solicitation of an offer to buy or sell any securities/schemes or any other financial products/investment products mentioned in this article to influence the opinion or behaviour of the investors/recipients.
Any use of the information/any investment and investment related decisions of the investors/recipients are at their sole discretion and risk. Any advice herein is made on a general basis and does not take into account the specific investment objectives of the specific person or group of persons. Opinions expressed herein are subject to change without notice.
Feature Presentation: Ashish Narsale/Rediff
© 2025