The Right Theme At The Wrong Time Is Still The Wrong Investment

When you invest in a broad index fund, you are essentially buying a slice of the entire market. Thematic investing works differently. Here, you pick a specific investment idea or theme and put money into the sectors and companies likely to benefit from that theme playing out. The portfolio is built around a common opportunity, and everything in it is connected to that opportunity in some way.

The appeal is real. When a theme plays out, and the macro environment lines up with the right sector at the right time, returns may be potentially higher than the broad market. But getting there is challenging.

The first difficulty is understanding how sectors behave in different economic environments. Sectoral performance does not follow an obvious script. A look at calendar year returns across sectors like IT, pharma, banking, infrastructure, and FMCG over the past decade shows one clear pattern: the winner keeps changing. A sector that led the market one year may underperform the next. What drives this is the relationship between macro conditions and sectors. GDP growth, fiscal deficit, currency movements, crude oil prices, and current account position all influence which sectors are likely to do well in a given period. Tracking all of this consistently, with the right data and the time to analyse it, is something most individual investors might find difficult to do.

The second challenge is emotional. Markets go through periods of extreme optimism and extreme pessimism, and thematic investing amplifies both. When a sector is doing well, money chases it. When it turns, the losses can be sharp. The dotcom era is a useful example. The Nifty IT Index rose by over 740% between February 1999 and February 2000. When the bubble burst, the index fell 64.9% over the following year. Something similar played out with pharma between June 2015 and June 2018. The pharma fund category saw its AUM grow 69% as investors piled in after a strong run. The three years that followed delivered a CAGR of -12% from the Nifty Pharma Index.

The flip side of emotional investing is that good opportunities get missed, too. During the 2013 taper tantrum, when India’s macro was under pressure with high fiscal deficit, high inflation and a weak rupee, the environment was actually favourable for export-oriented sectors like IT and pharma, which earn their revenues in dollars. But most investors, focused on domestic gloom, did not act on it. The entry window was open, but the inclination to invest was low at exactly the point when it should have been high.

The third challenge is taking the exit at the right time. Deciding when to exit a theme and where to redeploy the money is as important as the initial investment call. This is where a lot of value gets lost in practice. Investors either exit too early, before the theme has fully played out, or they hold too long and give back gains already made. And whenever they do sell and switch, capital gains tax applies, and the timing and structure of the exit affects how much of the return actually stays with the investor.

Thematic funds can help address these challenges. They follow a structured framework for identifying themes, deciding portfolio allocations, monitoring developments over time, and determining when to rebalance or exit. For investors with a long-term horizon, thematic funds can therefore serve as a useful complement to a diversified equity portfolio.

Disclosure: This article is written by Mohammed Ismail, Managing Partner of IA SQUARE ASSOCIATES MK LLP. The views expressed are his own. This is partner content and not an Outlook Money editorial feature. Outlook Money does not provide investment advice or endorse any products or services mentioned. Mutual Fund investments are subject to market risks, read all scheme related documents carefully.

Disclaimer: The Views are Personal and not a part of the Outlook Money Editorial Feature