Sectoral and thematic mutual funds is seeing a great run; what's driving this growth?

Due to the combined impact of the government’s emphasis on public sector undertakings (PSUs), coupled with a thrust on infrastructure, sectoral mutual funds ended up receiving significant attention from investors last year.

This is evident from the fact that more than 19% of the funds invested in equity schemes were directed towards sectoral and thematic funds last year. These mutual fund schemes experienced an inflow of Rs 30,841 crore, second only to small-cap mutual funds, which received a net inflow of Rs 41,035 crore, or over 25% of the total equity inflows. Fund managers anticipate that sectoral funds will continue to attract robust flows, and sectors such as infrastructure, banking, housing, pharmaceuticals, and manufacturing appear promising for the next two to three years.

The journey so far

It is interesting to see that PSU funds outpaced other categories for the second straight year in 2023. On an average, mutual funds that zero in on public sector enterprises delivered 59.22% returns to investors last year and 26.51% in 2022. “The outperformance of the PSU space can be attributed to segments like PSU banks and defence,” says Vrijesh Kasera, Fund Manager at Mirae Asset Investment Managers (India). He adds that given the sharp run-up in both the segments, the valuations look expensive with respect to their historical averages. “While the rally may continue in the short-term, the earnings in both the segments will have to match up to justify the prevailing valuations.”

Among the top mutual funds in the PSU category, the net asset values (NAV) of Aditya Birla Sun Life PSU Equity Fund, Invesco India PSU Equity Fund, SBI PSU Fund and ICICI Prudential PSU Equity Fund gained somewhere between 55-62% in 2023.

For Rishiraj Maheshwari, Founder and CEO of RISCH Wealth & RISCH Family Office, the reason could also be that investors are now focussing more on diversification. “With an increasing influx of retail SIP investments, investors are now seeking additional diversification options. They are directing more [money] towards sectoral and thematic funds due to reforms in sectors such as power, PSUs, railways, infrastructure, and others,” he says.

With average returns of 45.17%, infrastructure is next on the list. Investors believe that the government’s thrust on this sector is expected to drive the capital expenditure (capex) cycle, which has been on a downturn for almost a decade. The government had announced a record capex of Rs 10 lakh crore in the Union Budget 2023-24 and Rs 11.1 lakh crore in the Interim Budget for 2024-25.

Explaining the factors that may lead to record high capex, Anish Tawakley, Deputy CIO-Equity at ICICI Prudential AMC, says, “One key theme is urbanisation. Today, 36% of households stay in an urban setup. As this ratio increases, demand for real estate, social and other urban infrastructure will also increase. Second is the increased government focus to augment the road and rail network. And finally, as utilisation levels improve, corporate capex is expected to increase. For example, the power sector is expected to see reasonable capex as utilisation levels have gone up and due to transitioning to cleaner fuels.”

With returns of 59.03%, Nippon India Power & Infra Fund topped the list among infrastructure funds in 2023. HDFC Infrastructure Fund and Invesco India Infrastructure Fund also posted returns of 56.54% and 53.25%, respectively, in the previous calendar year.

Pharma is another key sector. In 2023, pharmaceutical funds recovered, posting returns of 34.65%, after a fall of 10% in the previous year. Money managers foresee a positive outlook for the domestic pharma sector due to cost optimisation and reduced competitive intensity. According to experts, Indian pharma companies have benefitted from a robust domestic market. They also hold the highest number of US FDA-approved plants outside the US. The market is anticipated to reach $65 billion by the end of 2024 and $130 billion by 2030, compared to $50 billion in mid-2023. Data available with Value Research shows that the top-performing funds in the sector include ICICI Prudential Pharma Healthcare and Diagnostics (with returns of 42.55%), Nippon India Pharma Fund (40.36%), and SBI Healthcare Opportunities Fund (39.72%).

Technology funds were also back in the black in 2023 after witnessing heavy selling pressure in 2022. Data showed that technology as a category, which mostly includes IT funds and IT ETFs, delivered an average return of 30.14% in 2023 against a fall of 23.04% a year ago. However, at present, fund managers are cautious on the IT sector for the near-term considering the ongoing slowdown in the developed markets.

“A global slowdown, lower IT spending, and commodity and wage inflation are putting downward pressure on the IT companies from a near-term perspective. Add to this, the emergence of disruptive AI technologies is further clouding the near-term outlook. Hence, we are underweight on the sector,” says ICICI Prudential’s Tawakley.

The banking sector, which delivered an average return of 18.69% in 2023, too looks attractive to fund managers. Chandraprakash Padiyar, Senior Fund Manager at Tata Mutual Fund, says, “The banking sector is going through a sweet spot from a credit cost perspective. Earnings growth is likely to be in healthy double digits and valuations for most banks are trading at lower than averages, leading to a favourable outlook over the next two to three years.”

ETFs or mutual funds?

Asked whether investors should put money into exchange-traded funds (ETFs) or mutual funds, Kotak Mahindra AMC’s CIO Harsha Upadhyaya says ETFs are more cost efficient than regular active funds. However, an investor should not make investing decisions solely based on costs. ETFs by design can never outperform their respective benchmarks, while active funds have the potential to outperform their respective benchmarks despite slightly higher costs. The investing decision should be made keeping needs and expectations in mind, say experts.

For Kasera of Mirae Asset Investment Managers (India), the decision between the two ultimately depends on a finer understanding of what each has to offer. “A sector-focussed ETF closely tracks the performance of the underlying sector index and usually carries a lower TER (total expense ratio)/cost. On the other hand, an active sectoral fund, despite a relatively higher TER/cost, has the potential to generate alpha, that is, generate better returns than the underlying index through its differentiated stock selection approach within the sector,” he says.

Sectors to consider

While keeping his preference towards diversified funds like large- and mid-cap, flexi-cap, and multi-cap funds, Padiyar of Tata Mutual Fund suggests sector-specific investors to allocate their wealth in sectors like banking, real estate, infrastructure and manufacturing. “The key reason is the prospect of consistent growth in earnings and scaleability that these sectors offer along with reasonable valuation,” he says.

On the other hand, Mihir Vora, Chief Investment Officer of TRUST Mutual Fund, believes that the domestic economy will do better than the global economy. So, he prefers sectors that will benefit from domestic investments and consumption. On an average, consumption funds posted returns of 28.76% in 2023, as opposed to 7.28% in 2022.

“Government spending on infrastructure will continue at a good pace, which should be backed up by the private sector investment cycle picking up. So, we are talking about sectors like capital goods, construction, infrastructure assets, utilities, power, renewables, defence and railways. Within consumption, we are looking for signs of a pick-up in the discretionary space like automobiles, paints and retailing,” adds Vora.

 

@iamrahuloberoi