Investing in popular sectors or themes with the hope of beating the market can sound like a smart strategy. But in reality, consistently outperforming a diversified portfolio through active sector or thematic bets is as difficult as timing the market—often with results no better than a coin toss.
The challenges of picking winners
Sectors can appear attractive due to a mix of factors: regulatory changes, new product launches, global trade shifts, interest rate movements, government policies, or temporary commodity and currency disruptions. But understanding how these macroeconomic forces interact—while also evaluating company-specific aspects like leadership and execution—is no easy task, especially for retail investors.
As a result, most retail investors tend to make sectoral or thematic investment decisions based on two things: recent market performance of the sector, or media hype fuelled by product launches or industry narratives.
Also read: How red tape is costing public sector bank employees crores in NPS savings
Boom, bust, repeat
The stock market is forward-looking—it often prices in expectations long before actual results show up. This creates a cycle of booms and busts across sectors:
IT stocks soared between 1997–1999 (NSE IT Index: +173%, +193%, +493%), only to crash in the following three years (-35%, -36%, -6% from 2000–2002).
Pharma had a strong run from 2012 to 2015 (+32%, +26%, +42%, +10%) and then posted four straight years of negative returns (-14%, -7%, -8%, -9%).
Infrastructure, real estate, power, and NBFCs saw massive gains before events like the Global Financial Crisis or IL&FS collapse triggered steep declines.
Chemical stocks surged in 2020 and 2021 (+46% and +69%) but have since delivered lukewarm single-digit returns.
Even if an investor correctly identifies a sector on the rise, they still need to exit before the tide turns. That means getting both the entry and the exit right—a double challenge. Statistically, if the odds of one correct decision are 50%, the chances of nailing both fall to just 25%.
The limits of sectoral funds
One of the key limitations of sectoral investing is the narrow mandate that many of these funds operate under. Since sectoral funds are bound to invest only within a specific sector—say, IT or pharma—fund managers have little flexibility.
They are often forced to include nearly all companies in that sector, regardless of quality. This reduces the manager’s ability to generate alpha through stock selection. As a result, the fund’s performance is almost entirely driven by how the overall sector performs, not by active fund management.
Also read: Are sector rotation funds the answer to risks of sector downturns?
A smarter approach for retail investors
A more robust strategy, particularly for retail investors, lies in diversified portfolios managed by professionals who can actively adjust sector weights as market conditions evolve.
For conservative or first-time investors, it is advisable to start with broad-based investment options such as exchange-traded funds (ETFs), index funds, or diversified equity mutual funds that automatically spread risk across sectors and market caps.
Aggressive or more experienced investors can consider a core-satellite strategy—where 75% or more of the equity allocation is invested in diversified funds (like flexi-cap or multi-cap funds), and the remaining 25% is deployed tactically in sectoral or thematic funds based on strong, well-researched convictions.
Even here, thematic funds may be safer than pure sectoral funds, as they cut across industries. For instance, a “capex” fund might include exposure to cement, utilities, auto, power, and real estate—providing broader diversification while still capturing a specific investment theme.
Be careful with sector-specific funds. It’s hard for individual investors to consistently pick winning sectors better than professional fund managers. You might end up disappointed.
Instead, it’s often smarter to let professional fund managers make these active choices within a diversified fund. This gives you much better chances of success.
Also read: Why balanced advantage funds are back in focus for moderate risk investors
Nishant Agarwal, senior managing partner, ASK Private Wealth.
