Sectoral fund inflows down 75% from peak, 19% of schemes at losses: Report

The euphoria around sectoral themes like defence, PSU and manufacturing is settling as the flows into sectoral/thematic funds have been slowing down since September 2024, down by almost 75 per cent from the peak. 

 

Domestic flows slowed down in February 2025 to ₹29,000 crore from ₹40,000 crore in January 2025. Almost all category funds witnessed a slowdown but the largest slowdown came in sectoral/thematic funds. Inflows into thematic funds declined to ₹5,712 crore which is the lowest in 10 months, according to a report by Elara Capital.

 

Euphoria reminds of 2007-2008 crisis

 

Redemptions have not yet started from defence and PSU funds, but inflows have slowed down significantly. “We have been repeatedly highlighting our concern on sectoral funds since September 2024 because of the resemblance of the euphoria which was last seen in 1998-2000 and 2006-2008 period,” Elara Capital said. 

 

 

A rapid increase in the assets under management (AUM) of this category has reflected excess greed in the system. “The old saying is that if investors start aggressively moving into this category, return expectations from markets have reached an irrational zone,” it added.

 

Concentrated buying in select stocks by these funds also pulls the valuations of other stocks in the sector higher, resulting in a direct and indirect impact on valuations. 

 

Analysts at Elara Capital raise concerns because a major portion of the thematic/sectoral flows came much later in the cycle and is already sitting on losses. The currency AUM of these funds as a percentage of total India’s market cap has surpassed 2008-09 levels. In the previous cycle, the bulk of inflows came in the last six to nine months before the Global Financial Crisis (GFC). 

 

Currently, 19 per cent of the sectoral schemes are trading at more than 10 per cent loss and around 25 per cent of schemes are sitting on negative returns. 

 

“In 2008, we saw the first spike in March 2008 after which markets tried to stabilise. However, the next round of correction from May 2008 created mayhem in these stocks. Currently, we seem to be in that recovery phase (like March 2008-May 2008). Closure of schemes in this category was only visible from May 2011,” the report added. 

 

Additionally, in February 2025, equity funds recorded an addition of 1.8 million folios, which is the slowest monthly addition since November 2023. This was largely on the back of slowest folio addition in midcap, smallcap and sectoral funds. 

 

The report also raised concerns that a bulk of new investors in midcap and sectoral funds came into markets post-election results of June 2024. A meaningful portion of these investors are already sitting on losses.

 

Although, we have still not seen much impact on flows, these could be initial leads of flows turning weak going ahead, the report said.