Sure you have come across the terms sectoral fund and thematic fund, often used loosely by investors. But they are not the same. While a sectoral fund invests in a particular industry sector, thematic fund can invest in diverse sectors around a particular opportunity or a business ‘theme’.
A thematic fund is an equity mutual fund that invests in stocks around a theme that could be infrastructure, commodity, rural India, international etc.
They tend to be attractive to retail as well as institutional investors, who often call it ‘performance tracing with a narrative’. These funds come with a great story and a bunch of stocks that generate impressive returns.
Investment approach
Consider this: A fund manager or an asset management company (AMC) identifies growth potential or consumption boost in a particular theme, say opportunities in real estate/housing. The AMC may launch, say, a ‘Housing Opportunities Fund’ that will invest in a range of sectors like housing finance, consumer electronics, cement, banks, steel, power and more.
A thematic fund can invest across different sectors and market caps (large cap, mid cap, small cap) as long as it conforms to the housing theme. The minimum investment in equity and equity-related instruments of a particular theme should be 80% of the asset under management (AUM), mandates SEBI.
Thematic funds use a top-down investment approach. For a particular theme, the asset manager first takes a broad view of the economy and markets, including global trends. If there is enough opportunity, the asset manager or AMC begins to investigate related sectors and individual stocks to invest.
1. IT or Digital Funds
2. Pharma Funds
3. MNC Funds
4. PSU Funds
5. Dividend Yielding Funds
6. Infrastructure Funds
Advantages
Thematic funds are all the rage, ever since the pandemic ebbed and the markets returned to high growth path. Recent news reports indicate returns of thematic funds, such as public sector undertaking (PSU), infrastructure, consumption and information technology fared well, compared to the large-cap fund category in the past one year. Analysts say, these funds are cyclical in nature and have given higher returns during the period.
High returns for each ‘theme’ have respective opportunity factors. For example, attractive valuation and hope for privatisation have led to major rerating in PSU stocks. The government’s infrastructure push has led to a rally in the sector. The technology sector, despite corrections, continued to remain one of the top performers in the past few years. Growth opportunities, as such, make thematic funds attractive to long-term investors.
Thematic funds also have some inherent advantages compared to sectoral funds and mutual funds that follow conventional investment strategies. As we already know now, a thematic fund is more diversified than a sectoral fund, having its investments diversified in several sectors and not just in one.
Most importantly, it offers an investor the opportunity to invest in theme-related sectors that have a high growth potential.
Here’s more:
>Since thematic funds invest in stocks and sectors that are closely related in their business scope, the fund is more focused and easy to track
>Since thematic funds carry a high degree of risk, they are likely to deliver high capital appreciation in the long-term
>Since certain themes like information technology (IT), robotics, EVs, renewable energy and the sunrise sector projects significant growth potential, retail investors can take the advantage of early investment. One can increase allocation in these industries/themes by taking higher exposure in relevant themes if convinced with the improving environment for the industry.
Disadvantages
>Thematic funds are more volatile and riskier than the conventional equity funds
>Portfolio diversification is an essential part of effective investment strategy. But thematic investments can make investors put too many eggs in one basket and lose sight of portfolio diversification
>Thematic opportunities, if misinterpreted by the fund managers (who are caught up in their idea of what will be the next big trend), can lead to losses
>Yes, a lot depends on the tactical approach of fund managers. Best returns from thematic investment depend on the fund managers’ market timing. Unless stocks are bought low and sold high, thematic investment cannot offer the expected results
>Often performance-chasing by retail investors is negative for thematic funds. This is because most of the time when investors enter certain theme, valuations have already peaked and the fund has turned expensive
>Most retail investors lack the knowledge, research capability and temperament to sustain the volatility associated with thematic investments. As such, analysts suggest that novice retail investors should avoid thematic funds and stick to vanilla diversified funds
>The more exotic a fund gets, costs tend to rise, because things may not be competitive in those niches. So, an investor ends up paying more expense ratios.
