The year 2025 witnessed a powerful rally in specific sectors of the Indian stock market, leading to stellar performances by focused mutual fund schemes. However, this surge has reignited a critical debate among financial advisors: are the potentially high returns from sectoral and thematic funds worth the inherent volatility and risk they carry?
Outsized Returns in a Moderate Market
While broader equity indices posted moderate gains, a handful of concentrated strategies delivered exceptional performance. Funds tracking the Nifty PSU Bank Index emerged as the top performers, delivering returns of approximately 26%. They were closely followed by the Nifty Metal index, which rose about 24%, and the Nifty Auto index, which gained around 20%.
The rally in public sector bank stocks was fueled by a favourable macroeconomic environment. Factors such as falling interest rates, improved liquidity conditions, and relatively attractive valuations helped state-owned lenders outperform their private-sector counterparts.
Similarly, auto stocks benefited from a steady recovery in vehicle demand and improving consumer sentiment. Metal stocks rode the wave of higher commodity prices and positive global cues. Another notable performer was the defence sector, where stocks rose nearly 19% during the year, supported by increased government spending and growing export opportunities.
The Allure and The Inherent Danger
According to Sirshendu Basu, Head of Product Management and Strategy at Bandhan Asset Management Company, these funds offer targeted exposure to long-term structural trends that might be diluted in a diversified equity portfolio. In the right market phase, a well-timed allocation can significantly boost overall portfolio returns.
However, this potential comes with a significant caveat: elevated risk. Sectoral funds are inherently more volatile due to their concentrated exposure. "Leadership in sectors can change quickly," cautioned Vishal Dhawan, Founder and CEO of Plan Ahead Wealth Advisors.
This volatility is not theoretical. The Nifty Realty Index, for instance, delivered spectacular returns of 81% in 2023 and 34% in 2024, only to decline by over 16% in 2025. Auto and metal stocks have also experienced sharp swings historically, underscoring how rapidly sectoral cycles can reverse.
Prudent Strategies for Investors
Given these risks, financial advisors unanimously recommend a cautious approach. They suggest using sectoral and thematic funds only as a satellite allocation, never as the core of an investment portfolio. Timing is another critical and challenging factor.
"Sectors and themes are cyclical and carry significant timing risk, both at entry and exit," explained Kaustubh Belapurkar, Director of Manager Research at Morningstar Investment Research India. He suggests that phased investing, or systematic investment plans (SIPs), can help mitigate this risk by averaging the cost across different market conditions.
For investors unsure about picking the right sector or managing the volatility, diversified equity funds remain the preferred choice. These funds allow professional managers to take calibrated overweights and underweights in sectors without exposing the investor to extreme concentration risk. First-time and less experienced investors are generally advised to avoid narrow sectoral bets altogether.
Even for seasoned investors, discipline is paramount. Over-allocating to a hot sector or chasing recent performance often leads to disappointment when the cycle turns. Successful sector investing requires patience, periodic review, and a willingness to rebalance when the original investment thesis weakens. It demands regular tracking and near-perfect timing for entry and exit—a skill most retail investors are not expected to possess consistently.
