Mutual Funds invest in securities, be it equity or debt, whose values fluctuate along with market movement. This makes them risky because NAV of the fund depends on the individual security values held in the fund’s portfolio. But since mutual funds invest in securities across different sectors, they diversify this market risk. Since a fund invests in many securities, the risk that all of them will go down in value on any day is reduced. Thus, it is true that mutual funds diversify risk, but they don’t eliminate it. The diversification followed by a fund manager reduces the market risk of the fund to the extent of diversification. The more diversified a fund is, the less risky it is.
Concentrated funds like thematic or sector funds are riskier than multi-cap funds because any unfavourable market condition will impact all the companies of the affected sector in some way or the other while in a multi-cap fund, the diversification across sector and capitalization works like an airbag during a car accident, reducing the impact of the unfavourable condition on the fund’s NAV.
When you invest in Mutual Funds, look at the degree of diversification in the fund’s sector allocation. Depending on your risk-taking ability, choose a fund with the right kind of diversification that’ll suit you.