Both timing and selection are crucial. The funds selected should remain relevant for the long term, while also outperform the broader market index
Thematic funds are fast becoming a darling of all retail investors. To the uninitiated, they are a category of funds that invest in emerging opportunities across sectors. Their increasing popularity is driven to a large extent by the rising awareness of the common investor to spot the popular mega trends in investing.
The trend is further buttressed by the products launched by the asset management companies, which are easy to understand, and resonate well with investors’ aspirations to capture the trends. Little wonder, the best thematic funds are the ones with the most visited pages among retail investors, as they park more of their disposable income into equities through mutual funds.
Right Choice
Thematic funds received net inflows of Rs 25,024 crore in the last one year, accounting for nearly 20 per cent of the total net inflows in equity funds, and the second highest after the flexicap category. The assets under management (AUM) of thematic or sectoral equity funds rose 64 per cent year-on-year to Rs. 1.46 trillion in January 2022, while the total equity AUM increased by 50 per cent in the same period.
Timing plays a crucial role in the selection of thematic funds. The selection should be done in a way that it remains relevant for the long term, while also outperforming the broader market index in a dynamic world.
Historical data suggests that the market winners have been changing consistently. Thus, sticking to a particular theme for a long period could prove detrimental. For instance, in 2021, the power sector was the top performer, followed by metals with 66 per cent returns, while in 2020, the healthcare sector became the top gainer with 61 per cent return. In fact, the top sector gainer of the last two years was never a top performer in the last 10 years.
Keep Emotions At Bay
What convolutes the situation further for investors is the emotions that lead to investing in a sector when it’s ‘red’ hot due to the fear of missing out. Late entrants of the ‘red’ hot sector typically remain out of pocket for a very long period. For instance, an investor invested in a tech-based thematic fund on the basis of 740 per cent returns recorded between 1999 and 2000 would have witnessed a massive correction in fund value when the dotcom bubble burst. The Nifty IT index in the following year delivered a return of 64.9 per cent.
Furthermore, common investors could find it difficult to find correlation between macros and the market, given the limited resources and time constraints. Interestingly, even tracking the right theme and the right funds, but entering at a wrong time could depress and destabilise the portfolio returns. Therefore, to get optimal returns, a proper entry and exit strategy is quintessential, particularly the later one due to the element of taxation.
Over the long term, the optimal approach to generate superior returns is by investing through a thematic fund. Many of such funds follow a Fund of Funds (FoF) methodology, as it helps to invest in a bouquet of funds, aiding diversification and providing a hedge from concentration risk associated with sector-specific thematic funds. Global research shows that the survival rates of thematic funds over a period of 15 years is just over 20 per cent. Therefore, thematic funds based on FoF methodology offer a promising return and stability, as it has the flexibility to change the weight of thematic sector funds depending upon the earnings prospects seen over the medium term.
Thematic funds can be a good option if you are keen on saving taxes while earning healthy returns. The tax advantage stems from the fact that investors who remain committed for at least three years will be eligible for indexation benefits as per the Income Tax regulations.
Further, the scheme aims for the right mix, curating a portfolio which is neither too concentrated nor too diversified, thus striking an optimal balance between growth and risk mitigation. Thus, as an investor, one can benefit from the growth potential of value-generating emerging sectors while keeping an eye on relevant market movements.