Hot sectors? Just index it

Summary: Sector investing no longer has to mean stock picking. With the rise of sectoral ETFs, investors can take focused exposure to industries through low-cost, rules-based indices, while avoiding many of the mistakes that hurt active sector funds.

For years, passive investing was largely synonymous with broad markets. Investors who chose index funds or ETFs accepted a simple trade-off: give up the possibility of outperformance in exchange for low costs, transparency and consistency. That trade-off made most sense in large-cap equities where active managers struggled to beat benchmarks with any reliability.

But when it came to sectors, the rules were different. Sector investing was considered a playground for stock-pickers. Banking, Pharma, Technology or Energy exposure was supposed to be built by identifying the right companies at the right time. Passive investing stopped at the market-cap boundary.

That distinction is now fading.

The steady rise of sectoral index funds and ETFs has quietly altered how investors can access sector exposure. What was once an active-only domain can increasingly be navigated through rules-based, low-cost instruments. In the process, the need for active stock selection within sectors has reduced more than many investors realise.

What sectoral ETFs get right

Sector investing has always carried two layers of risk. The first is choosing the right sector at the right time. The second is choosing the right stocks within that sector. Active funds attempt to manage both.

Sectoral ETFs strip away the second layer. By construction, they hold the leading companies in a sector, weighted by market capitalisation or another transparent rule. There is no discretion involved, no style drift and no dependence on a fund manager’s judgement.

This matters because historically, a large part of sector fund underperformance came not from getting the sector wrong, but from stock selection errors within the sector. Concentrated bets, timing mistakes and excessive churn often hurt outcomes even when the broad sector performed well.

For instance, Nifty PSU Bank ETF delivered annual returns of 36 per cent over the last five years; however, your performance would have been very different if you actively picked stocks like Punjab & Sind Bank and UCO Bank in the index by giving them more weight, as they delivered only 16 per cent and 18 per cent annual returns in the same period.

Passive sector funds remove that variable. Investors now express a view on a sector, not on individual companies. That is a meaningful simplification, especially for those who lack the time or expertise to track balance sheets, management quality and competitive dynamics within every industry.

The numbers tell the story

Assets under management (AUM) in sectoral ETFs have grown steadily over the past five years. Banking ETFs have expanded from roughly Rs 29,000 crore in 2021 to over Rs 46,000 crore in 2025. Technology ETFs, despite periods of global volatility, have maintained sizable asset bases. Infrastructure and consumption ETFs, once niche categories, have seen consistent growth. Even sectors like Pharma, traditionally considered stock-picking heavy, have witnessed a six-fold rise in ETF assets over this period.

This growth is not just an AUM illusion driven by market rallies. Liquidity has improved meaningfully as well. Average daily turnover data for 2025 shows that several sectoral ETFs now trade in volumes that were unthinkable a few years ago. Banking and technology ETFs regularly see daily turnover running into multiple crores. PSU and infrastructure ETFs have also developed reasonable depth. Even sectors with smaller investor bases, such as Dividend Yield or ESG, now show enough activity to allow entry and exit without excessive friction for most retail investors.

You win if the sector wins

The rise of sectoral ETFs does not mean investors should suddenly chase sectors. But it does change the toolkit available to them.

Earlier, an investor who believed that Banking or Infrastructure would outperform had little choice but to either buy individual stocks or rely on an actively-managed sector fund. Both options required faith in a manager’s ability to make the right calls within the sector. Today, that same investor can take a cleaner view. If the thesis is that the sector as a whole will benefit from economic, regulatory or structural tailwinds, a passive ETF is often sufficient. The investor captures the sector’s aggregate performance without worrying about which company wins the internal race.

This is particularly relevant in sectors where leadership shifts over time. In Technology or Pharma, today’s leaders are not guaranteed to remain dominant a decade later. An index automatically adjusts for this. Companies that lose relevance drop in weight or exit the index, while new leaders enter. The investor does nothing.

Lower costs, fewer moving parts

Cost is another quiet advantage. Sectoral active funds often carry higher expense ratios than diversified equity funds, justified by the research effort involved. Sectoral ETFs, in contrast, tend to be cheaper and more predictable in their costs. Over long holding periods, this difference compounds.

More importantly, passive sector investing reduces decision fatigue. There is no need to evaluate fund manager changes, investment style shifts or portfolio churn. The rules are known upfront and remain consistent. This does not eliminate risk, but it does make the risk more visible. What you see is what you get.

What it does not solve

Sectoral ETFs do not protect investors from bad sector calls. If a sector goes through a prolonged downturn, a passive fund will fully participate in that decline. There is no defensive positioning, no cash buffer and no selective avoidance of weak companies.

Sector investing also remains cyclical by nature. Flows often peak after strong performance and dry up after prolonged underperformance. Passive instruments can amplify this behaviour because they make sector rotation easier to execute.

Liquidity, while improved, is still uneven. Banking and technology ETFs are far easier to trade than niche sectors. In smaller segments, spreads can widen during volatile periods.

Finally, sectoral ETFs do not replace the need for asset allocation discipline. Overexposure to one or two sectors can distort portfolio risk, regardless of whether the exposure is passive or active.

The bottom line

The real shift is not that passive investing has conquered sectors. It is that active stock selection within sectors is no longer a necessity for most investors.

Sectoral ETFs allow investors to separate two decisions that were previously intertwined. The decision to back a sector and the decision to back specific companies. For many, making only the first decision is challenging enough.

Used judiciously, sectoral ETFs can complement a core diversified portfolio. They allow targeted exposure, transparency and ease of execution, without the complexity of stock picking. But they also demand restraint. Sector bets should be limited in size, grounded in long-term reasoning and reviewed periodically. Passive instruments make execution easy. They do not make judgment irrelevant.

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This article was originally published on February 01, 2026.