Thematic Funds Can Generate Alpha But Know The Risks And Keep A Long Term

The fifth edition of the investor awareness and education webinar, spearheaded by Mirae Asset Mutual Fund and powered by Outlook Money, was on what thematic funds are and how should investors approach them. In conversation with Nidhi Sinha, editor, Outlook Money, was Vaibhav Shah, head – Product, Marketing and Corporate Communications, at Mirae Asset Investment Managers (India) Pvt Ltd. Here are the edited highlights of the discussion:

What Are Thematic Funds?

A thematic fund invests in a combination of many sectors. For example, in the banking and financial services theme, you would have various segments which such as banking, NBFCs, insurance, mutual funds, broking and wealth management. A banking sector fund, on the other hand, will only invest in banking stocks.

A thematic fund invests in businesses which are ancillary and work within the same space. Thematic funds work on a certain style and theme of investing.

Consider The Risks

Thematic funds are great to invest if the investor understands what the theme stands for and how long is the play.

Usually, concentration risk is higher in thematic funds. While most diversified funds have 50-60 stocks in their portfolios, thematic funds have only 20-30 stocks. Moreover, diversified funds are spread across many sectors, while thematic funds are concentrated only on a few sectors and, therefore, a lower number of securities.

Also, not all great themes translate into market returns. For instance, in the last 10 years, real estate prices have more than doubled in many parts of India, but the sector would not have given that much return on the stock market.

Moreover, since thematic funds invest in one or more sectors, they become more cyclical in nature, which means a regulatory change or a different market environment could impact a sector more than the broad market. For example, during the pandemic, sectors like banking were hit, but certain sectors like IT did exceptionally well. Thematic funds could go through phases where there is underperformance over a short period of time, so investors need to have a longer time frame.

Investors need to work on an asset allocation and financial planning strategy along with an advisor. In mutual funds, you would try and create core portfolios, which could consist of large-cap, mid-cap and flexi-cap funds. To complement this portfolio, you could have a satellite portfolio which can be built with thematic funds. Experts usually recommend that sector funds should not be more than about 10 per cent of the portfolio (15 per cent for very aggressive investors).

Sectors to Invest In

Globally, a lot of themes are emerging that are currently not present in India. For example, electric vehicles, robotics artificial intelligence and blockchain are coming out as huge themes. Investors who want to include these themes can look at global funds.

Investors should invest in themes that are structural in nature, which means you should have an investment time frame.

In India, consumer is going to be a huge theme. India has a population of more than 130 crore, but the median age is 27 years, which means most Indians will be working for the next two decades and will become natural consumers. But this theme is not relevant for one or three years; it can be played over, maybe, one or two decades. So, it’s a structural long theme.

Another long-term structural theme is healthcare. The pandemic has taught us that what is most important is not wealth alone but also your health.  Healthcare will emerge as a big theme because you will want to play healthcare in various ways—through diagnostic companies, hospitals, pharma companies.

Banking and financial services is another one. There are less than 5 per cent people in India who have investment in mutual funds. When you consider products like insurance less than 10 per cent of the people in India have insurance products. So financial services industry is going to see a sea change and it is a structural theme.

Alpha Generation

If thematic funds can’t deliver alpha, then there is no case of investing in them. If your tenure is long, say, five, seven or 10 years, they can deliver significant alpha. It needs to be noted that the performance of thematic fund tends to be more cyclical. So, within a time frame of six months or a year, you would see that some of these thematic funds could underperform large-cap or mid-cap funds.

However, entry and exit from any investment should be based on how close your goal is and when you need the money.

DISCLAIMER : Views expressed are the author’s own