When you invest in specific sectors or disciplines and they perform well, the returns can be phenomenal. But it can backfire if the choices are wrong.
In recent times there has been increasing interest in regional and thematic funds, 12,500 crore so far in 2022 alone.
One of the considerations to go ahead with such investments is to choose the right sector that is likely to perform well, and be successful in timing the investment – entry and exit.
Here are some factors you must understand to make sectoral and thematic funds and ETFs work to your portfolio advantage.
Markets reward different sectors at different times
In March 2020, as COVID-19 hit the world, software companies transitioned to the work-from-home (WFH) regime and were able to win strong digital transformation deals from global customers. Revenue and profit growth for these companies was strong. As a result, the S&P BSE The IT index was up 55% and 56% in CY21 and CY20, respectively. As internet usage increased due to the WFH event, telecom stocks and telecom indices also did well. Subsequently, the IT sector is down about 25% so far in 2022, as fears of a slowdown affecting IT customers in the developed economies of North America and Europe, resulting in lower budgets and spending have gripped the markets.
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As COVID-19 spread in 2020 and 2021, and the world looked for drugs, vaccines and effective treatments to tackle the pandemic, the pharma sector did very 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 comes to an end.
After nearly four years in the slow lane between 2017 and 2021, the Indian automobile sector has come back in the past year or so. With passenger car sales expected to reach an all-time high of 38 lakh units – the sector’s fortunes look strong. The index is up about 21% in this calendar year till September. This, after a rally of 18% in CY2021. With rising per capita income and an increasing tendency to spend on discretionary goods, there could be ample scope for companies in this sector to rally further. Investors can take exposure in auto themes through the auto ETF or auto index fund route.
Another sector that holds promise is banking, which is on the mend and poised for a strong revival. The Indian banking sector is adequately capitalized and the decline in bad loan provisions reflects the health of the broader economy. As domestic demand for financial services improves and lending from the corporate sector picks up, the Indian banking sector will see a recovery in earnings. It presents an attractive Investment Opportunity for a savvy investor. One can invest in the banking sector through the ETF or index fund route. Therefore, a sector rotation works at different points in each market cycle.
Timing is key to making a winning move
Some sectors like banking and auto are cyclical and go through ups and downs depending on their business dynamics and overall macroeconomic factors. Subjects like infrastructure depend on the fate and direction of economic development. Therefore, as investors, it is important to get the right point of entry into a sector. It is also important to leave at the right time.
After seeing two good years for the IT sector, if you entered the sector in late 2021 or 2022, your investments would have declined by 25%. Specific stocks would have declined further. On the other hand, the turnaround in power sector stocks earlier this year may have given handsome returns.
Fitting sectoral and theme funds and ETFs into your portfolio
Investors need to research thoroughly to choose the sector that is most likely to perform at a particular point in time, zero in on stocks in that segment, and time buy and sell decisions. This challenge is addressed with the help of a financial advisor.
An effective way to accelerate a sector or theme is through funds tracking such a segment.
Investors should note that their core portfolio should consist of only balanced leverage funds and equity funds diversified based on their asset allocation pattern, risk appetite and target time frame. These regional ETFs and funds should make up a small portion of their satellite portfolio to provide an additional kicker (or alpha) to the returns of their core portfolio.
Chintan Hariya is Head of Product Development and Strategy at ICICI PrudentialAMC
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