Sectoral and thematic index funds have drawn fresh attention as some of these strategies delivered returns of up to 22% over the past six months. With broader benchmark indices offering relatively muted gains in recent years, many retail investors are looking at narrower passive funds that focus on specific themes or industries.
But the appeal of recent performance can hide a key issue: these funds often track concentrated indices. Sectoral indices such as the Nifty India Defence can be market-cap weighted, which means a small number of large companies may account for a big share of the index. That can increase risk if the sector falls out of favor or if a few stocks face pressure.
For retail investors, understanding how an index is built matters as much as the recent return numbers. Index construction, stock concentration, weighting method and periodic rebalancing can all affect how a fund behaves in different market conditions. A passive label does not automatically mean lower risk when the underlying basket is narrow.
The broader takeaway is that sectoral and thematic funds may work better as satellite holdings rather than the core of a portfolio. Investors are generally advised to keep sector exposure limited to around 15% to 20% of their total allocation while using diversified equity funds for broader market participation and better balance across sectors.
