Sectoral Funds: Understanding the Attraction and Risks

Overview

As of January 2026, sectoral and thematic funds constitute approximately 43% of the 550 odd equity schemes in the Indian fund industry, with the highest number of folios at over 3 crore. Despite their highly volatile performance, many investors continue to be attracted to these funds.

Investor Behavioral Biases

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Investors' behavioral biases often play a significant role in their investment decisions. The Recency bias, where investors give too much importance to recent events, information, or data over historical data and long-term trends, is a common bias among investors. This bias can lead to performance chasing in cyclical sectors, resulting in suboptimal outcomes.

Performance Chasing

The CRISP Mutual Funds Scorecard (December 2025) highlights how sectoral and thematic funds have consistently attracted strong inflows following periods of sharp outperformance, only to see elevated redemptions when cycles reverse. Analysis of rolling three-year data showed that investors who shifted into the best-performing sector based on past returns earned materially lower subsequent returns compared to broader market indices.

Cyclical Nature of Sectoral Funds

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At any given point in time, there will always be one or two sectors that have significantly outperformed the broad-based indices or diversified equity funds. However, such performance tends to be cyclical, and the outperforming sectors tend to rotate over time. For example, among the seven sectors analyzed, the IT sector was among the top two best-performing sectors in 2024, but it is the worst-performing sector in 2025.

Suitability of Sectoral Funds

We believe sectoral funds are niche products that are suitable for select investors who have:

• A high degree of experience and risk appetite
• The ability to evaluate cycles that may be hard to sustain consistently
• The discipline to navigate the sharp ups and downs

Unless one has the expertise to navigate the risks associated with sectoral funds, it is often wiser to avoid them and stick to core equity categories.