Thematic Fund Of Funds: A Prudent Way To Invest In Theme

The allure of sectoral and thematic funds is rapidly gaining momentum, driven by the expanding breadth of Indian bourses. With India’s market capitalization surpassing $5 trillion, the nation now ranks among the top five global economies by market value. The growing fascination with thematic funds is evident from net inflows of ₹1.4 lakh crore in the first eleven months of 2024, accounting for 40% of total equity inflows. In contrast, AMFI data shows net inflows of ₹24,835 crore, or 17% of total equity flows, during the same period last year. Robust inflows and capital appreciation have propelled sectoral and thematic funds’ AUM to ₹4.61 lakh crore, making them the largest in the equity fund category.

This remarkable milestone was achieved by surpassing large-cap and flexi-cap funds in AUM over the past year, registering an impressive growth rate of 95%— highest among all equity fund categories.

While the concentrated bets of thematic funds often yield lucrative returns, they are among the riskiest propositions for retail investors. Success, in this domain, requires staying acutely attuned to emerging trends in the equity markets that can generate extraordinary profits. For instance, post-pandemic, the surge in consumer discretionary spending, driven by the “revenge buying” phenomenon and the popularised sentiment of “You Only Live Once,” became a lucrative theme. Similarly, the massive re-rating of the Electronics Manufacturing Services sector followed as global corporations sought diversification of their supply chains beyond China, capitalizing on India’s labour cost advantages.

However, navigating sectoral performance requires a nuanced understanding of its interplay with macroeconomic indicators—something that often eludes retail investors due to limited resources and time constraints. A telling example is the currency depreciation of 2013 when India was listed among the “Fragile Five” economies during the taper-tantrum period. While heightened risks dissuaded retail investors from equities, some institutional funds seized the opportunity by increasing their exposure in Indian IT companies. The rupee depreciation significantly bolstered the IT sector’s revenue growth, whose earnings are largely denominated in foreign currency, leading to an outperformance of the IT index by nearly 30%.

Another challenge lies in the ever-changing landscape of sectoral winners. Over the past decade, the banking sector emerged as the top performer in four years, while the auto sector, despite its recent limelight, claimed the top spot only twice in the same period. This constant flux in sectoral leadership makes it exceedingly difficult to anticipate the next sunrise sector. Moreover, emotional biases often impair retail investors’ decision-making at critical junctures. At market lows, despondency leads them to exit equities entirely, while at market peaks, heightened optimism results in overexposure, leaving them vulnerable to steep drawdowns during corrections.

So, how can retail investors effectively leverage the sectoral theme without succumbing to these challenges? The answer lies in Thematic Fund of Funds (FoFs) managed by Asset Management Companies. These funds are designed to actively track macroeconomic trends and identify potential growth themes. After meticulous evaluation of valuation metrics, they curate a diversified portfolio by allocating appropriate weights to both major and minor themes or sectors.

This structured approach offers several advantages, it ensures active monitoring of market trends, strikes a balance between concentration and diversification, enhances tax efficiency, and provides a well-planned exit strategy. For common investors, thematic FoFs thus represent a prudent and efficient way to participate in the dynamic world of sectoral and thematic investing.

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