Opt for thematic offerings only if you can time your entry and exit

Most investors should stick to diversified funds where fund manager has the leeway to exit non-performing themes and sectors

The booming stock market over the past year-and-a-half has made fund houses come out with new thematic/sectoral offerings to attract investors. Special situations, business cycles, quant, Environmental, Social, and Governance (ESG) are already here and some new age ones like electric vehicles are round the corner. Some recent offerings include ABSL Business Cycle Fund, IIFL Quant Fund and ITI Pharma and Healthcare Fund.

“Thematic funds are being launched to attract investors when markets are at all-time highs and investors are not comfortable making fresh investments in their existing schemes at these levels,” said Omkeshwar Singh, head of RankMF, Samco Group.

Fund houses have tried to sell thematic offerings even in the past. Between 2003 and 2007, the infrastructure or Build India theme was the talk of the town. Funds dedicated to power and commodities also made a big splash for a brief period. However, over a period of time, barring a few themes such as consumption, most have not found favour with investors due to their highly cyclical performance. While consumption theme funds have given a category average return of 17.02 per cent return over the past 10 years, infrastructure funds have given 13.05 per cent. Flexicap funds have given 15.63 per cent return over the same period of time, according to data from Value Research.

Potential for high returns

Thematic funds are meant for savvy investors looking for specific solutions and high returns if those themes click. “The key benefit of investing in such a fund is that it focuses on a specific theme and delivers superior returns if the theme does well,” says S Sridharan, founder, Wealth Ladder Direct.

Concentration risk

Most themes and sectors are narrow. People investing in these schemes run high concentration risk. “Thematic strategies usually provide concentrated exposure to a particular sector or set of companies. Since the positions are concentrated, if the theme or sector doesn’t perform, the tracking error vis-a-vis market returns can be significant,” says Vishal Dhawan, chief financial planner, Plan Ahead Wealth Advisors.

A fund manager who senses that the theme/sector’s fundamentals are deteriorating, or that it is slowing down, cannot exit his positions. “The fund manager does not have the option to take exposure to other sectors or themes as it is mandatory to invest 80 per cent in the theme/sector to which the fund belongs,” says Sridharan.

Past returns are no guide

Investors often chase themes that have done well in the recent past. Take the example of healthcare funds, which were under immense pressure till the second half of 2019. That sector gained traction during the Covid-19 pandemic but lost steam after the first half of FY2021, as investors started betting on the opening up trade. These funds would have been disastrous for investors who invested in October to December 2020 based on past performance. Returns from these funds have been suboptimal over the past year—28.04 per cent compared to 50.2 per cent from flexi-cap funds.

Investors need to get the timing of entry and exit right to make money in thematic and sector funds. “These funds are inherently risky bets if the entry is not timed properly depending on underlying market or economic conditions,” says Dhawan.

Should you invest?

While those with high risk appetite may consider thematic/sectoral offerings, most investors are better off sticking to diversified equity funds. Thematic funds are best left to investors who know the fundamentals of the theme/sector and can time their entry and exit right. “Investors who can tolerate the high risk in these funds and stay invested over a 7-10-year period may allocate up to 10 per cent of their equity portfolio in them. Those with shorter horizons should avoid these funds,” says Sridharan.

Dhawan advises a wait-and-watch approach. “Allow a new thematic offering to build a robust track record before participating in it, unless it is truly unique,” he advises.