Thematic funds shine, but can be riskier

Most thematic funds have beaten the benchmarks and other asset classes. This has taken some shine off the diversified equity funds

Thematic funds are back with a bang if one looks at the returns generated by pharmaceutical, IT, FMCG and banking sector-focused funds in the last five years - one of the toughest phases for the Indian stock market. Most of these thematic funds have beaten the benchmarks and other asset classes by a wide margin. This has taken some shine off the classical diversified equity funds.

If an investor had invested Rs 100 in thematic funds at the beginning of 2009-10, the value of the same would have galloped to Rs 200-400, depending on the scheme, provided he remained invested throughout this period.

ICICI Prudential Technology Fund gave a compound annual return of 38.3 per cent over the past five years, while the fund house's Taxplan growth fund, a diversified equity scheme, generated a 26.9 per cent return in the same period. Similarly, returns by Reliance Pharma Fund were 35.5 per cent against 29.8 per cent from Reliance Equity Opportunities.

Experts, however, say thematic funds don't always outperform. Every industry follows a growth cycle and they out-perform the broader market in their upcycle and vice versa. This makes returns from thematic funds volatile and riskier, compared to diversified funds where the fund manager can change sectoral weightages, say experts.

"Focused funds predominantly make investment bets based on the near to mid-term term outlook of a particular sector or theme. Their performance is, therefore, skewed by how favourably the drivers of the sectors play out," explains S Naren, chief investment officer at ICICI Prudential Mutual Fund.

Since investors are under-invested in equities, it would be advisable to maintain the core portfolio holdings through diversified equity funds, he says. "Such funds have demonstrated superior performance through various cycles," adds Naren.

According to sector experts, focused funds are only for seasoned investors.

Navneet Munot, chief investment officer and executive director of SBI Mutual Fund, says, "While larger allocations should be in diversified equity funds, investors may look at small allocation to thematic or sector funds as a tactical call."

But timing is important. Infrastructure funds are classic examples. Launched primarily between 2005 and 2008, amid an infrastructure boom, investors pumped money in "infra funds" but returns eluded them in the wake of the 2008 Lehman crisis.

However, to investors who still prefer thematic funds, Naren has some advice: "If there is a stable government, we believe infrastructure and mid- and small-caps will do relatively better."

Agrees Niranjan Risbood, director (funds research) at Morningstar India. "Thematic funds are clearly the riskier of the two options. The strategic long-term allocation to equities for the client needs to be done through diversified equity funds," he says.