Thematic And Sector Funds: Why India Needs A Regulatory Rethink

Thematic and sector-based mutual funds have emerged as one of the fastest-growing categories in India’s investment landscape. Their appeal is obvious: they allow investors to participate in focused trends such as technology, consumption, manufacturing, defence, energy transition, and more recently, AI. These funds offer the thrill of concentrated bets, the potential for higher alpha, and access to sunrise opportunities that larger, more diversified funds may not fully capture.

However, while global markets view thematic funds as narrow, tactical tools, an increasing number of Indian retail investors are treating them as long-term investments. This shift raises a critical question: are existing regulations aligned with how these funds are actually being used? And is there a need for a framework that better guides and protects investors?

“Today, India has over 150 thematic and sector schemes. Many of these are launched during periods of peak optimism in specific sectors. For instance, the technology sector in 2020, pharmaceuticals in 2021, energy in 2022, and PSUs and manufacturing in 2023–24. Historically, sector funds tend to attract large inflows after strong performance cycles, which can increase volatility and make sharper drawdowns more likely when trends reverse,” says Anand K. Rathi, Co-Founder, MIRA Money.

While SEBI regulations clearly define what constitutes a thematic or sector fund, there is limited guidance on assessing investor suitability, communicating risk, or planning for long-term holding periods.

The first area where we need a rethink is investor awareness and risk disclosure. Retail investors often enter these funds expecting consistent returns similar to diversified equity funds. But by design, thematic and sector funds carry concentration risk - if the chosen theme underperforms, the investor bears the full impact. This requires stronger, more visible risk labelling, clearer communication on cyclicality, and mandatory performance disclaimers that highlight historical volatility of the theme.

“Second, there is a case for tighter suitability assessment. Many developed markets classify thematic funds as advanced-investor products. They require either advisory oversight or a suitability check before allocation. In India, however, these funds are available freely, often purchased impulsively through apps or influenced by momentum narratives. Introducing basic suitability filters - for example, limiting first-time investors or encouraging capped exposure unless advised - could improve long-term investor outcomes,” says Rathi.

Third, India needs better categorisation discipline. Themes today can be broad, vague, or overlapping - for example, “multi-theme innovation”, “global opportunity”, “manufacturing plus”. A more streamlined definition of what constitutes a valid theme or sector will prevent fund houses from launching trend-driven products that may not have sustainable long-term investment logic. Clearer categorisation will also make comparison easier for investors.

Fourth, regulators could consider guidelines on the timing and manner of communication around new fund offers (NFOs). Sectoral NFOs are often launched when valuations are elevated and investor sentiment is strong. While restricting launches may be neither practical nor desirable, ensuring that NFO communication is more fact-based and less sentiment-driven would improve clarity and reduce the risk of mis-selling.

“Meanwhile, we must also acknowledge the positive side: thematic funds, when used wisely, can be powerful tools. They allow investors to back India’s structural themes - manufacturing, defence, renewables, financialisation, exports - all central to our economic momentum. They generate genuine excitement and participation in India’s growth story,” says Rathi.

The key is balanced regulation - not restrictive, but protective.

India is entering a decade of rapid transformation and thematic funds will continue to attract interest. A thoughtful regulatory rethink will ensure that while innovation thrives, investor outcomes remain at the centre.

The objective must be simple: to help people invest smarter, safer, and more sustainably. With clearer guidelines, stronger disclosures, and improved suitability frameworks, thematic and sector funds can evolve from momentum-driven bets into strategic long-term instruments aligned with India’s developmental priorities.