The Reality of Thematic/Sectoral Funds: Short-Term Buzz, Long-Term Struggles

Introduction:

What are Thematic and Sectoral funds?

In the world of equity investing, mutual funds come in many flavours. Among the most talked-about are Thematic and Sectoral Funds, which attract investors by offering a chance to capitalise on the growth of a specific idea, industry, or trend. These funds invest in narrow areas—a single sector like Banking or IT, or a cross-sector theme like Infrastructure. Their performance is directly tied to the fortunes of that single idea.

However, while these funds generate buzz, a more reliable path to long-term wealth is often found in diversified equity funds. This article examines the data and reveals why the hype surrounding thematic funds often leads to disappointing long-term results, underscoring the superior risk-adjusted performance of diversified funds for the patient investor.

A Flood of Money into "Hot" Themes: The Investor Craze

Recent years have seen explosive growth in thematic and sectoral funds, fueled by eye-catching returns in sectors like PSUs, Defence, and Energy

Assets Under Management (AUM): Between December 2020 and December 2025, the AUM for thematic/sectoral funds grew at a compound annual rate of 44.98%, clearly outpacing the 31.55% growth seen in the broader equity funds universe.

Source: AMFI. 
(Past performance may or may not be sustained in future and is not a guarantee of any future returns.)

New Schemes: In the same five-year period, 143 new thematic/sectoral funds were launched, mobilizing ₹1,50,207 crore, significantly more than the 100 new diversified equity funds, which raised ₹95,863 crore.

Source: AMFI

The message is clear: investors are flocking to what’s “hot.” But history suggests caution. While thematic funds may deliver spectacular returns during boom cycles, most fail to sustain performance against diversified funds in the long run.

Data Driven Reality Check: Long-Term Performance of Diversified and Thematic/Sector Schemes

Investor enthusiasm often assumes that higher risk should translate into higher reward. The long-term rolling return evidence, however, challenges this assumption.

Across 10-year rolling observations (based on 5-year rolling return windows from 2016–2026), diversified equity funds have exceeded the performance of thematic and sectoral funds — despite taking significantly lower concentration risk.

Note:
1)* In Diversified Funds, we have included Largecap, Large&Midcap, Midcap, Smallcap, Multicap, Flexicap, Contra, Value, Dividend yield, ELSS & Focused Fund
2) The analysis covers a 5-year rolling return period, specifically from February 13, 2016, to February 13, 2026. This span includes 1,826 total observations.
3) Source: ACEMF

Past performance may or may not be sustained in future and is not a guarantee of any future returns.

The median rolling return of diversified funds stands at 16.10%, compared to 15.68% for thematic/sectoral funds. While the difference may appear modest at first glance, the risk-adjusted characteristics of the diversified equity funds tells a more compelling story.

• Lower downside risk (better minimum returns and lower drawdown)
• Zero probability of loss on a 5-year rolling basis 
• Greater consistency in delivering returns above 8% (96.79% vs. 92.06%)

This is particularly important because thematic and sectoral strategies inherently assume concentration risk — investing heavily in a narrow slice of the economy. If this additional risk does not translate into materially superior long-term returns, the fundamental risk–reward equation becomes unfavourable.

The rolling return evidence highlights a key insight: higher concentration risk has not resulted in superior long-term outcomes.

However, statistical outcomes alone do not fully explain the structural drivers behind this pattern. Sector leadership is cyclical — phases of strong outperformance are often followed by extended periods of stagnation. During these phases, investors who enter at peak optimism can find their capital locked in low-return environments. This cyclical stagnation helps explain why concentrated strategies struggle to sustain long-term outperformance, as illustrated in the next section.

The Cycle of Stagnation: “When the Hype Fades: Real-World Examples”

Sector performance is inherently cyclical — marked by sharp expansion phases followed by prolonged periods of underperformance. This boom–bust dynamic makes sustained long-term outperformance difficult for narrowly focused strategies.

And that brings us to real-world examples of how “hot” sectors eventually cool — sometimes for years.

History offers plenty of reminders that what’s “hot” today often turns cold tomorrow. Several sectors that once captured investor imagination later went through years—sometimes decades—of underperformance.

Take the IT sector, for instance. During the 1999–2000 technology boom, IT funds and stocks soared on promises of a digital future. Yet, after the bubble burst, the sector delivered one of the weakest returns for the next decade, with many investors waiting years just to break even.

Source: ACEMF 

Between July 1999 and February 2000, the IT sector delivered an unbelievable 600% return in less than a year. Naturally, investors saw this massive rally and rushed to put their money into IT funds. This is classic FOMO investing — fear of missing out.

But what happened next?

From the peak in February 2000 to October 2001, the index crashed by nearly 90%. Imagine investing ₹10 lakh at the peak — it would have fallen to nearly ₹1 lakh. Years of savings were wiped out.

And the most painful part?

It took approximately 13.5 years just to recover to its previous high. That means investors who entered at the peak had their money stuck for over a decade, earning zero real progress during that time.

This is the biggest risk of thematic or sectoral funds:

• They are highly concentrated.
• When the cycle turns, the fall is equally dramatic.
• Recovery can take many years, sometimes decades.

A single sector goes through long cycles of boom and bust. Timing those cycles consistently is extremely difficult — even for professionals.

This is why diversification is critical.

Diversified equity funds spread investments across sectors — IT, banking, pharma, FMCG, auto, energy, etc. When one sector crashes, others can cushion the fall. You avoid extreme drawdowns and reduce the risk of long-term capital erosion.

A similar story unfolded in Pharma. After an exceptional run till 2015–16, driven by strong exports and defensive demand, the sector stagnated for nearly six years before regaining momentum.

Source: ACEMF 

These examples are not isolated; numerous other sectors and themes have experienced significant underperformance after periods of intense public interest. And beyond performance, these “boom and fade” cycles often come with heightened volatility and deep drawdowns — the true cost of chasing trends.

To move from anecdotal evidence to measurable reality, we now examine how sectoral strategies behave when evaluated through volatility, drawdowns, and downside statistics — compared against a broad benchmark like the NIFTY 500 TRI.

This is where the true difference between concentration and diversification becomes evident.

Volatility, Drawdowns – The Risk Side

Returns alone never tell the full story. Risk defines the investor experience.

Let’s evaluate sectoral indices against the broader NIFTY 500 TRI. To judge that, we look at four metrics:

• Volatility: Measures fluctuations in returns.
• Max Drawdown: The biggest peak-to-trough fall, showing how much an investor could have lost.
• Minimum returns: The lowest return an index or fund has delivered during the analysis period.
• Negative observations: The percentage of time periods (e.g., rolling windows) when returns were negative.

(Period Dec 2010 till Dec 2025)

Note: *Minimum Returns & Negative observations are calculated on a 3-year rolling returns basis from period Dec 2010 till Dec 2025

Source: ACEMF 

Across volatility, sector-focused approaches exhibit materially higher fluctuations than the diversified benchmark. Higher volatility translates into sharper interim swings, increasing the emotional and behavioural pressure on investors.

When measured through maximum drawdowns, the contrast becomes even clearer. The broad-market index has historically experienced shallower peak-to-trough declines, whereas concentrated strategies have endured much deeper corrections. Larger drawdowns not only extend recovery time but also increase the probability of investors exiting at the wrong moment.

Downside frequency further reinforces this pattern. Taken together, the evidence is straightforward:

These higher risks have not been accompanied by proportionately higher long-term returns. In effect, the additional concentration risk has increased uncertainty without delivering a consistent reward premium. This highlights the fundamental advantage of diversification: it reduces the amplitude of market cycles while preserving long-term growth potential.

No Sector Wins Forever: The Boom-Bust Cycles

The core risk of sectoral and thematic investing lies in its reliance on timing—a skill that even professional investors struggle with. The sectoral heatmap from 2015 to 2025 tells the real story. It shows how leadership keeps rotating — making timing the sector virtually impossible for investors.

Note: All returns are expressed as percentages and are based on Total Return Indices (TRI).

Source: ACEMF

Sectoral outperformance phases are often driven by liquidity surges, earnings acceleration, or valuation re-rating. However, as cycles mature and valuations normalize, mean reversion tends to compress returns.

Chasing the "hot" sector is more like gambling than investing. A diversified fund solves this problem. By its very nature, it holds a mix of sectors, capturing gains from the year's leaders while being cushioned from the inevitable decline of yesterday's favourites. It removes the impossible burden of market timing from the investor.

Conclusion: Build Your Core with Diversification

The narrative behind thematic/sectoral funds—investing in the future of energy, defence, or technology—is undeniably compelling. However, the data reveal a less attractive reality.

Rolling return data shows that, despite taking materially higher concentration risk, thematic and sectoral funds have not consistently delivered superior long-term returns compared to diversified equity funds. At the same time, they exhibit higher volatility, deeper drawdowns, and greater cyclicality.

Sector leadership rotates unpredictably. What outperforms in one phase often underperforms in the next. Sustained success in thematic/sectoral investing, therefore, requires precise entry, exit, and timing — variables that are difficult even for experienced investors to execute consistently.

For investors, the message is clear: do not get carried away by short-term hype. Your long-term wealth is far more likely to be built on a core of diversified equity funds that balance risk and reward across all market cycles. Thematic funds are best treated as small, "satellite" holdings for flavour, not as the foundation of your financial future.

As one saying goes: “In investing, excitement often fades, but discipline compounds. Thematic funds may spice up a portfolio, but long-term wealth is built on diversification, patience, and resisting hype.”

Disclaimer: The information contained herein is only for information and does not constitute, and should not be construed as investment advice or a recommendation to buy, sell, or otherwise transact in any security or investment product or an invitation, offer or solicitation to engage in any investment activity. Mutual fund investments are subject to market risks, read all scheme-related documents carefully before investing.