Thematic funds are highly risky, not for everyone

In the last one year, over a dozen thematic funds were launched in the market. Thematic funds are equity mutual funds that invest in different sectors and companies of a particular theme. “These funds carry a single theme but may have stocks from different sectors,” said Harsha Upadhyaya, chief investment officer-equity, Kotak Mahindra Asset Management Co Ltd. For example, if the theme is financial services, it will include stocks from sectors such as banking, insurance and mutual funds.

According to Value Research data, 50% of asset management companies offer thematic funds. Are you interested in thematic funds because you think a particular theme, say consumption, infrastructure or financial services, is going to be popular? Well, before you venture into it, here is what you should know:

Performance and parameters

Firstly, know that the risks associated with a thematic fund are higher because the scope of the stocks it is invested in is concentrated. “High net-worth individuals (HNWI) who want to take the extra risk of beating the markets can look at thematic funds,” said Prabin Agarwal, founder of Siliguri-based PrabinAgarwal Wealth Management. He further says that out of the total funds launched last year, none of them have done spectacularly well.

Secondly, remember that in terms of performance, thematic funds are cyclical in nature. “Thematic fund portfolios usually invest in one or more sectors and hence, become cyclical in nature, resulting in heightened volatility in the portfolio. We believe that high volatility products are not best-suited for retail investors. Therefore being a retail-focused asset management company (AMC), we have avoided thematic funds so far,” said Alok Singh, chief investment officer of BOI AXA Mutual Fund, one of the AMCs which does not offer thematic funds.

Also, while considering thematic funds, you need to look at valuations. “Investments into sector or a thematic fund is generally advisable when the sector or the themes under consideration are available at attractive valuations,” said Rajat Chandak, fund manager at ICICI Prudential AMC. An attractive valuation signifies a fair value of the security and the current worth of the company. There may be noise about certain sectors performing well. However, there is no guarantee that it will do so. Say there is news of the incumbent government promising investments in infrastructure, new roads and Metro lines. But this does not ensure that infrastructure as a theme will do well. “It may be easier to bet on the infrastructure theme, but there is a gestation period and all themes undergo cycles of being bullish and bearish,” said Upadhyay.

External environment can play a part too. Macroeconomic aspects such as gross domestic product, crude oil prices and interest rate make or break a theme. “For example, when it comes to automobiles, robust GDP is a positive. Falling crude oil price and reduction in interest rates has a reasonably positive impact on this space too,” said Chandak.

In the past, there have been times when sectors have had a good run but eventually they see a downfall and investors lose their money. For instance, after registering a healthy compounded annual growth rate (CAGR) of around 14% during FY08 to FY13, the pharmaceutical market growth slowed down to around 10% CAGR during FY13-FY18 on account of pricing regulations from 2013-14 onwards, according to a report by Crisil, a credit-rating agency.

“So portfolio of investors who may have invested on the back of robust double-digit growth suffered in the last two to three years,” said Prabin. Another example is the focus on technology companies in 2000, luring people to add more of tech funds in their portfolio. “Some investors even had 60-70% of their portfolio bent towards IT stocks but after the dotcom bubble, they lost 40-50% of their portfolio value,” said Neeraj Chauhan, chief executive officer (CEO) of New Delhi-based The Financial Mall.

What should you do?

Experts at HTMoney spoke to retail investors against investing in such concentrated mutual funds because a major decisions like timing the market, supervising the market movements and decision to stay invested or not stays with the investor. “Irrespective of any events happening in the economy, good or bad, the fund manager has to stay invested in thematic funds unlike diversified funds where the portfolio is flexible,” Upadhyaya said. To invest in thematic mutual funds, active involvement and knowledge are required. If you want to invest in thematic funds, you must consult a financial advisor.

“A maximum of 5-6% of your portfolio should be exposed to thematic funds,” said Aggarwal. Thematic funds are highly risky and not meant for everyone. Also, you need to get the timing right in this, which is extremely difficult to do. Hence, tread carefully if you must.