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Can sectoral funds be used to boost your overall portfolio returns?

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When you invest in specific sectors or themes and they do well, the returns can be phenomenal. But it could also backfire if the choices are wrong.

The interest in sectoral and thematic funds has been soaring in recent times, with inflows of 12,500 crore so far in 2022 alone.

The points to consider while going ahead with such investments are choosing the right sector that is likely to do well, and, success in the timing of investments—entry and exit.

Here are a few factors that you must understand to make sectoral and thematic funds and ETFs work for your portfolio gains.

Markets reward different sectors at different times

In March 2020, when covid -19 hit the world, software companies transitioned to work-from-home (WFH) regime and were able to win robust digital transformation deals from global clients. Revenue and profit growth was robust for these companies. As a result, the S&P BSE IT index was up 55% and 56%, respectively, in CY21 and CY20. As internet usage rose due to the WFH phenomenon, telecom stocks and the telecom index did well, too. Subsequently, the IT sector is down nearly 25% thus far in 2022 as fears of a recession in developed economies of North America and Europe affecting IT clients, resulting in lower budgets and spends, gripped the markets.

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As covid-19 spread in 2020 and 2021, and the world looked for medicines, vaccines and effective treatments to deal with the pandemic, the pharma sector did exceedingly well. The index was up 60% in 2020 and 10% in 2021. But the sector has been a big underperformer in 2022 as covid-19 abated.

After almost four years of being in the slow lane between 2017 and 2021, the Indian automobile sector is back in the reckoning over the last year or so. With passenger car sales expected to touch highest ever 38-lakh units—the fortunes of the sector appear robust. The index is up nearly 21% this calendar year up to September. This, after an 18% rally in CY2021. With increasing per capita income and rising propensity to spend on discretionary goods, there may be sufficient scope for companies in the space to rally further. Investors can take exposure to the auto theme through the auto ETF or the auto index fund route.

Another sector that holds promise is banking, which has been on the mend and is set for strong revival. The Indian banking sector remains sufficiently capitalized and the decline in bad loan provisions reflects the health of the broader economy. As domestic demand for financial services improves and credit borrowing from the corporate sector increases, the Indian banking sector will see improved earnings. It presents an attractive investment opportunity for a discerning investor. One can invest in the banking space through either ETF or index fund route. So, a sector rotation tends to play out at various points in each market cycle.

Timing is critical for making winning moves

Some sectors such as banking and auto are cyclical and go through ups and downs based on their business dynamics and overall macroeconomic factors. Themes such as infrastructure depend on the fortunes and direction of economic growth. Therefore, as investors, getting the right point of entry into a sector is critical. Also important is exiting at the right time.

After seeing two good years for the IT sector, if you entered the segment in late 2021 or 2022, your investment would have suffered a 25% erosion. Specific stocks would have fallen more. On the other hand, shifting to power sector stocks early this year may have delivered excellent returns.

Fitting sectoral and theme funds and ETFs into your portfolio

Investors are required to research well to choose the sector that is likely to perform at a particular point, zero in on the stocks in that segment, and time the buying and selling decisions. This challenge is addressed with the help of a financial adviser.

An effective way to play the upswing in a sector or a theme is via funds tracking such segments.

Investors must note that their core portfolios must consist only of balanced advantage funds and diversified equity funds based on their asset allocation pattern, risk appetite and goal timelines. These sectoral ETFs and funds must form a small part of their satellite portion to provide an additional kicker (or alpha) to the returns of their core portfolios.

Chintan Haria is head-product development and strategy at ICICIPrudentialAMC

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