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Beating the Downturn: How Sector Rotation Funds Can Keep You Ahead

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Over the last ten years, the value of thematic and sector funds has grown by 20 times, and the number of funds available has grown by three times. In 2024, sectoral and thematic mutual funds have achieved impressive double-digit returns, emerging as top performers. 

Points scored
Source: Sectoral, thematic mutual funds among top gainers in 2024 so far. Should you invest? – The Economic Times

However, each sector or theme has its own cycle, which is shaped by macroeconomics, government policies, global trends, consumer preferences, and a variety of other factors.

With unpredictable markets, the performance of sector—or theme-based funds also keeps rising and falling. However, there is a way to stay afloat—and even thrive. Enter sector rotation funds. 

These funds can help you avoid downturns and ride the wave of opportunity. Curious as to how? 

Let’s take a look at how sector rotation funds can help you stay ahead in choppy waters.

Understanding Sector Rotation Funds

Sector rotation funds are investment funds that strategically move investments from one sector to another based on economic and market conditions. This approach helps investors manage risks and capitalize on growth opportunities.

How do Sector Rotation Funds Work?

Let’s illustrate this concept with an example for better clarity.

When the Maharashtra government banned single-use plastics led to a significant increase in demand for eco-friendly packaging solutions. HUL, being a major player in the consumer goods sector, had to invest heavily in alternative packaging materials. 

This policy change initially caused a dip in HUL’s stock price due to the increased costs and operational adjustments required. However, over time, HUL’s proactive measures and shift towards sustainable packaging helped regain investor confidence, and the stock price recovered and even showed growth as the company aligned with the new regulations.

Remember, the Ukraine-Russia conflict dramatically affected the global energy sector. Disruptions in natural gas and oil supplies caused prices to spike. Energy stocks experienced volatility as markets reacted to geopolitical tensions. This created a chain reaction, leading to higher costs in various industries around the globe.

Here, when such uncertainties hit you, sector rotation funds come to your rescue. These funds reallocate investments from struggling sectors to those with better growth prospects. For instance, if the telecom sector in India faces challenges due to 

 changes, the fund might shift investments to more stable sectors like technology or healthcare.

Similarly, during the energy sector volatility caused by the Ukraine-Russia conflict, a sector rotation fund might move investments to sectors less affected by these geopolitical tensions, such as renewable energy or consumer goods.

By dynamically adjusting the portfolio, sector rotation funds help mitigate risks and enhance returns, keeping your investments resilient in changing market conditions. They allow you to stay ahead by capitalizing on sector performance shifts driven by local and global factors.

Benefits of Sector Rotation Funds in Downturns

Diversification: Sector rotation funds reduce the risk of over-exposure to a single sector by spreading your investments across various sectors. 

Adaptive Strategy: These funds dynamically adjust their investments based on market moods and trends. They move away from underperforming sectors to more stable or growing ones, ensuring better performance.

Risk Mitigation: By rotating out of struggling sectors, these funds help mitigate potential losses. This proactive approach can protect your investments from significant downturns.

Opportunistic Investments: Sector rotation funds capitalize on emerging opportunities in different sectors. They identify sectors poised for growth and invest in them, potentially increasing returns.

Enhanced Returns: With a focus on sectors with favourable outlooks, these funds aim to outperform the market. This can lead to higher returns compared to traditional funds during downturns.

Flexibility: Investors benefit from the flexibility to navigate changing market dynamics. Sector rotation funds can quickly respond to economic shifts, geopolitical events, and industry trends.

Long-Term Growth: Over time, consistent sector rotation can contribute to long-term portfolio growth. By avoiding prolonged exposure to downturns, these funds support steady performance.

These benefits highlight how sector rotation funds can be an effective tool to navigate economic downturns and maintain a healthy portfolio.

How to Identify key Sectors to Rotate Into and out of?

Investing through sector rotation involves strategically moving investments between different sectors to capitalize on growth opportunities and mitigate risks. Here’s how you can identify the key sectors to rotate into and out of:

  1. Analyze Economic Cycles

Understand the cycles of economy. Like, during economic growth, sectors like technology, consumer discretionary, and industrials often perform well. These sectors thrive due to a rise in consumer expenditures and corporate investments.

As the economy reaches its peak, sectors like energy and materials may show strong performance due to higher demand and commodity prices.

During economic slowdown or recession, defensive sectors such as healthcare, utilities, and consumer staples tend to outperform as they provide essential goods and services that remain in demand.

When economy recovers, financials and cyclicals often gain strength as confidence returns and businesses start to invest and expand again.

  1. Monitor Interest Rates

Keep an eye on the interest rates. Sectors like financials (banks) benefit from higher interest rates due to improved lending margins. Conversely, sectors with high debt levels, such as real estate and utilities, may suffer.

Technology and consumer discretionary sectors often benefit from lower borrowing costs, which can spur consumer spending and corporate investments.

  1. Evaluate Market Sentiment and Trends

When market sentiment is bullish, growth-oriented sectors like technology, consumer discretionary, and industrials can be attractive.

In a bearish market, investors may flock to defensive sectors like healthcare, utilities, and consumer staples to preserve capital.

  1. Assess Geopolitical and Regulatory Changes

New regulations can significantly affect sector performance. For instance, stricter environmental regulations can impact the industrial and energy sectors, while favorable policies can boost renewable energy and green tech.

  1. Review Corporate Earnings and Growth Prospects

Analyze quarterly and annual earnings reports to gauge the health and growth prospects of different sectors. Sectors with strong earnings growth may present good investment opportunities.

Also, consider the long-term growth potential of sectors based on technological advancements, demographic trends, and consumer preferences.

5 Top Performing Sectoral/ Thematic Funds

Franklin India Opportunities Fund (Thematic) 

The Franklin India Opportunities Fund is an open-ended equity fund that aims to generate capital appreciation by investing in opportunities presented by special situations such as corporate restructuring, government policy changes, and companies facing unique challenges. 

The fund focuses on themes like Make in India, Sustainable Living, and Digitalization.

NAV (as on 19th Nov)Rs. 263
Fund Size (in Cr)Rs. 5,610 Cr
Expense Ratio (in %)0.49%
3 Year Annualised Returns (%)25.08%
3 Yr Category Avg (in %)17.2%

Invesco India Financial Services Fund (Sectoral)

This fund invests in the financial services sector, which includes banks, insurance companies, and other financial institutions. It aims to benefit from the growth potential of the financial sector.

NAV (as on 19th Nov)Rs. 147.64
Fund Size (in Cr)Rs. 1,043 Cr
Expense Ratio (in %)0.93 %
3 Year Annualised Returns (%)17.38 %
3 Yr Category Avg (in %)12.3 %

Invesco India Infrastructure Fund (Sectoral) 

This fund targets the infrastructure sector, including companies involved in construction, engineering, and utilities. It seeks to capitalize on the growth opportunities in the infrastructure space.

NAV (as on 19th Nov)Rs. 74.40
Fund Size (in Cr)Rs. 1,666 Cr
Expense Ratio (in %)0.71 %
3 Year Annualised Returns (%)26.77 %
3 Yr Category Avg (in %)26.1 %

Bandhan Infrastructure Fund (Sectoral)

This fund focuses on the infrastructure sector, investing in companies that are involved in building and maintaining infrastructure projects. It aims to provide long-term capital appreciation by leveraging the growth potential of the infrastructure sector.

NAV (as on 19th Nov)Rs. 58.12
Fund Size (in Cr)Rs. 1,905 Cr
Expense Ratio (in %)0.81 %
3 Year Annualised Returns (%)28.13 %
3 Yr Category Avg (in %)26.1 %

Canara Robeco Consumer Trends Fund (Thematic) 

This fund invests in the consumer discretionary sector, which includes companies that sell non-essential goods and services. It aims to benefit from the growth in consumer spending and trends in the consumer discretionary space.

NAV (as on 19th Nov)Rs. 120.14
Fund Size (in Cr)Rs. 1,849 Cr
Expense Ratio (in %)0.84 %
3 Year Annualised Returns (%)16.75 %
3 Yr Category Avg (in %)17.6 %

The Key Takeaways

With over 180 sector or theme-based mutual funds in the market, picking the right fund can be challenging. However, switching between sectors or themes at the right time can be daunting because you have to keep a keen eye on the market movements and global economic arena.

This gives sector rotation funds an advantage over the traditional sector or thematic funds. They respond dynamically to market trends, reducing risks and capitalising on opportunities. 

However, choosing the right fund necessitates extensive research, market analysis, and a review of past performance. By carefully evaluating these factors, you can make more informed investment decisions and boost your portfolio’s resilience and growth potential.

FAQ

  1. How do sector funds differ from thematic funds? 

    Sector funds focus on a specific sector of the economy, like technology or healthcare. Thematic funds invest based on broader themes, such as renewable energy or aging populations, cutting across multiple sectors.

  2. Can sector/theme funds provide diversification benefits?

    While sector/theme funds can provide exposure to specific industries or trends, they may not offer the same level of diversification as broad-market funds. However, they can complement a diversified portfolio by adding targeted exposure to growth areas.

  3. What are the typical expense ratios for sector/theme funds? 

    Expense ratios can vary widely, but sector/theme funds often have higher expense ratios due to active management and specialized strategies. It’s important to compare costs before investing.

  4. Are sector/theme funds suitable for conservative investors?

    Sector/theme funds can be more volatile than broad market funds due to their focused investment approach. Conservative investors might prefer more diversified funds but can consider sector/theme funds as a smaller, complementary part of their portfolio.

  5. What should I consider before investing in sector rotation funds? 


    Before investing, consider factors like the fund’s historical performance, the expertise of the fund manager, transaction costs, and how well the fund’s strategy aligns with your investment goals and risk tolerance.

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I’m Archana R. Chettiar, an experienced content creator with
an affinity for writing on personal finance and other financial content. I
love to write on equity investing, retirement, managing money, and more.

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