Thematic Investing Isn’t DIY—Leave It To The Professionals

Most investors typically seek to allocate capital to funds composed of stocks that are considered market darlings, owing to the substantial growth potential they offer. For instance, India is currently witnessing an uptick in the contribution of manufacturing to GDP, a trend driven by concerted government initiatives. This has, in turn, created significant earnings potential within the manufacturing sector.

Investors pursuing such a rationale are essentially engaging in ‘thematic investing’—constructing portfolios around specific economic or structural themes. However, thematic investing is far from linear. It often encompasses multiple interrelated and ancillary sectors. To effectively capitalise on the manufacturing theme, for example, one must consider exposure not only to the core manufacturing firms but also to the companies involved in construction materials, construction equipment, steel production, and even new industrial ventures where the installed capacity is expanding.

Given the intricate interdependence among various sectors within a thematic approach, it becomes exceedingly difficult for the retail investors to implement such strategies independently. It is therefore prudent to pursue thematic exposure through any professionally managed thematic mutual funds, which are specifically structured to align with a well-defined theme.

One of the greatest challenges retail investors face is in identification of correlations between macroeconomic trends and thematic opportunities. With limited time and resources, retail investors often struggle to consistently track the multitude of variables necessary to make an informed decision. As a result, thematic investing is better left in the hands of professionals who possess the requisite analytical tools and the market insight.

Another significant risk is the inherent cyclicality of market themes. A sector that is currently favoured may lose momentum within months, potentially resulting in the investor entering at the peak of the cycle. This exposes one to the risk of a permanent loss of capital or prolonged periods of time correction, along with negligible returns. A historical case in point is the investors who entered the IT sector just prior to the dot-com crash or those who underestimated the upside potential of export-oriented sectors when India was part of the “Fragile Five” during the 2013 taper tantrum. These missteps often stem from emotional decision-making—particularly greed and fear—during the periods of market turbulence.

In contrast, the professionally managed thematic funds have demonstrated a superior ability to make timely and strategic calls. For instance, they invested in global funds in 2013 when the inflation and the current account deficit were at concerning levels, or in the gold funds when NBFCs exhibited balance sheet fragility and the corporate earnings growth was under pressure. Similarly, they made bold equity investments post-COVID-19, when the perceived threat had begun to recede.

A well-managed thematic fund incorporates several critical elements to optimise returns. These include active monitoring, a judicious balance between concentration and diversification, tax efficiency, periodic rebalancing, and timely identification of emerging themes. The investment philosophy is rooted in a data-driven framework, fund managers continuously analyse macroeconomic indicators to identify nascent themes, select relevant sectors and allocate weightages accordingly to best express the thematic conviction.

Moreover, thematic investments have become more tax-efficient. For example, Fund-of-Fund (FoF) structures for thematic strategies are now subject to a favourable long-term capital gains tax of 12.5% if held for more than 24 months—compared to the earlier regime where gains were taxed according to individual income tax slabs.

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