Is this the right time to invest in energy-sector mutual funds?

India is a fast-growing economy. Its energy needs are rapidly soaring. Our per capita electricity consumption has grown 15.23 per cent annually from 1985, reaching 1,255 kWh in 2022. So has our energy capacity, growing from 367.28 GW in December 2019 to 427.58 GW as of February 2024. This makes India the third-largest producer and consumer of electricity globally.

In light of this growing demand, this year's budget highlighted the government's push towards renewables, allocating Rs 600 crore to the National Green Hydrogen Mission and Rs 10,000 crore to solar projects.

Interestingly, just a few days after the budget announcement, SBI Mutual Fund launched its SBI Energy Opportunities Fund . This thematic fund collected a whopping Rs 6,547 crore during its NFO period. In the actively managed diversified equity funds space, it became the third-largest fund launch of this century after ICICI Flexi Cap and SBI Multicap .

So, does it make sense to invest in thematic funds focused on energy? Before we decide, let's examine how the energy index and energy-sector mutual funds have performed.

Performance of the Nifty Energy Index

Over the last five years, the Nifty Energy Index has consistently beaten the broader S&P BSE 500 TRI. The Russia-Ukraine conflict that started in February 2022 further emphasised the need for energy security, spurring demand for domestic renewable and non-fossil fuels.

Performance of energy-sector funds

There are only a handful of thematic funds focused on energy. Besides SBI's Energy Opportunities Fund, there are DSP Natural Resources and New Energy , Nippon India Power & Infra and Tata Resources & Energy funds. Among them, Tata Resources & Energy has shown impressive performance against its peers over a three-year horizon. It outperformed both the energy sector and the broader market index 59 per cent of the time.

However, when it comes to downside protection, Tata Resources & Energy Fund showed less resilience. It underperformed more than the S&P BSE 500 TRI in nine out of 22 instances when the market had delivered negative monthly returns between March 2019 and March 2024. In contrast, a consistently performing flexi-cap fund underperformed only four times in similar conditions.

The risk of concentration

Thematic funds focus on specific sectors or themes, potentially leading to increased volatility and risk exposure compared to more diversified funds. This lack of diversification can result in significant underperformance if the targeted sector faces downturns.

The table below shows the average allocation of top-performing energy stocks in energy funds during 2019 and 2023 (in six-month intervals) and compares it with those in focused and flexi-cap funds.

What you should do

Avoid thematic or sectoral funds due to their lack of diversification. These funds concentrate heavily on specific sectors, making them volatile.

A better alternative can be investing in diversified equity funds like focused and flexi-cap funds . These funds also have exposure to top-performing energy stocks, as shown in the table above.

That said, if necessary, thematic investments should complement, not dominate, your equity portfolio. They should offer additional exposure to sectors of your interest but should not be the cornerstone of your investment strategy.

Also read: Tata AMC launches six sectoral and thematic funds. Should you invest?