Fund houses are increasingly launching sectoral and thematic index funds and ETFs to track niche areas like pharma and defense. While these offer low-cost exposure, they carry timing and concentration risks that differ from broad market funds.
The landscape of passive investing in India is changing rapidly. While investors were traditionally limited to broad indices like the Nifty 50 or Sensex, mutual fund houses are now offering a wide array of sectoral and thematic index funds and exchange-traded funds (ETFs). These new offerings allow investors to gain exposure to specific industries, such as banking, metals, energy, chemicals, and defense, at a lower cost than active funds.
Why Sectors Are Drawing Interest
This shift is driven by the performance of specific industries which have recently outperformed broader market benchmarks. Between February and July 2026, the Nifty 50 TRI recorded a decline of 3.3%. In contrast, the Nifty Pharma TRI rose by 22%, and the Nifty Healthcare TRI gained 20.8%. Such returns have naturally shifted investor focus toward funds that track these high-performing niches.
Cost and Structure Considerations
One of the main advantages of these passive products is cost efficiency. Expense ratios for these funds generally range from 0.14% to 0.50%. Because these funds are passive, they aim to mirror an underlying index rather than rely on the stock-picking strategy of a fund manager. This eliminates the risk of human error or underperformance by a manager.
However, investors should be aware of how these indices are built. Most follow a market-capitalization-weighted approach, which means a few large companies can hold significant sway over the fund’s performance. For instance, in the Nifty India Defence index, major players like Hindustan Aeronautics and Bharat Electronics carry heavy weights. Additionally, some sector indices are quite narrow, sometimes including as few as 10 companies, which increases the impact of any single stock’s volatility.
Risks and Tactical Usage
Passive sector funds are not without challenges. Experts highlight that sectors are inherently cyclical, meaning they move through periods of growth and slowdown. Entering a sectoral fund when an industry is already at the peak of its cycle can lead to poor long-term returns. Furthermore, investors must account for tracking error—the difference between the index's performance and the fund's actual returns—which is particularly important when evaluating new fund houses.
For most investors, index funds are easier to manage as they do not require a demat account and support systematic investment plans (SIPs). ETFs offer intra-day trading flexibility but come with extra costs, such as brokerage fees, bid-ask spreads, and impact costs. Financial experts generally suggest treating these funds as satellite holdings, limiting their presence to 15-20% of a total portfolio. For those who cannot actively monitor sector cycles, diversified equity funds, where professionals handle asset allocation, remain a more stable choice. Investors should keep a close eye on the portfolio concentration of these funds and the tracking error before making allocation decisions.