Thematic Funds: Worth The Investment Risk?

Thematic funds are equity mutual funds that invest in stocks tied to a particular theme. For example, a fund with infrastructure as its theme will invest in companies in sectors like steel, cement, and construction. These funds are appealing to investors because they allow them to pursue market exposure to specific ideas. However, they are also risky because they lack diversification and are highly susceptible to market movements. Before investing in thematic funds, it is important to carefully analyse the theme prospect, investment risk, and taxes. It is also recommended that investors have a diversified portfolio and a good understanding of the sector or theme before investing in thematic funds.

Thematic funds are risky and susceptible to market movements

Thematic funds are open-ended equity schemes that invest in line with a predetermined investment theme. They are less concentrated than sector funds but more concentrated than diversified equity funds. This means that they can be a combination of industries. For example, a fund with an infrastructure theme will invest in companies from sectors like steel, cement, and construction.

Thematic funds are risky because they are dependent on one particular theme. If that theme does not play out, investors can face high losses. It can take a long time for a theme to play out, and there is a risk that it may take longer than expected or may never play out at all. For example, the infrastructure theme was popular in 2007, but over 10 years later, it still hasn't witnessed any real development.

Additionally, thematic funds are susceptible to market movements. For example, global tech stocks slumped 40-50% in line with weakness in broader markets. They are also subject to government, geopolitical, and geographical risks.

Due to these risks, experts advise that only investors with a high-risk appetite and a long-term investment horizon should consider investing in thematic funds. It is also important for investors to have a good understanding of the theme and its potential before investing.

They can be a good long-term investment strategy

Thematic funds are a good option for investors looking for good returns in the long term. They are equity mutual funds that invest in stocks tied to a particular theme, such as multi-sector, international exposure, export-oriented, rural India, etc. For example, a fund with infrastructure as its theme will invest in companies in sectors like steel, cement, and construction.

Thematic funds can be a good strategy for investors who are looking for market exposure to specific ideas. They allow investors to pursue these ideas across different sectors and market caps, as long as they tie back to the theme. This means that even if companies from one sector don't perform well, the other sectors will protect your portfolio from failing. For example, a fund with a manufacturing theme will invest in a host of companies that belong to different industries, from construction to chemical to engineering.

Thematic funds are also a good option for investors who are already in the market for a long time, understand the ups and downs, and have seen some cycles in the market. They can be a good addition to a well-diversified mutual fund portfolio in the home country, supplemented by a thematic investment in a foreign country portfolio. For example, developed countries offer good themes like green technologies, biotech, and climate change.

However, it is important to note that thematic funds are one of the riskiest mutual fund categories. They can be susceptible to market movements and negative triggers, and it may take a long time for the themes to play out and materialize into great investments. Therefore, it is recommended that first-time investors should not directly jump into thematic funds at the start of their investment journey.

They are not suitable for beginner investors

Thematic funds are risky investments that require a lot of research and monitoring. They are not suitable for beginner investors for several reasons.

Firstly, thematic funds require investors to have a good understanding of the chosen theme and its potential. Investors need to be able to identify trends and make informed decisions about the future performance of a particular sector or theme. This requires a high level of knowledge and experience in investing, which beginner investors may not possess.

Secondly, thematic funds are highly susceptible to market movements and can be impacted by various factors such as government policies, geopolitical events, and economic structural changes. Beginner investors may not have the experience to navigate these risks and make timely decisions to mitigate potential losses.

Thirdly, thematic funds often require a long-term investment horizon. Some themes may take a long time to play out and reach their full potential, which means that investors need to be patient and committed to their investment strategy. Beginner investors may not have the necessary experience or risk appetite to invest in such long-term opportunities.

Additionally, thematic funds lack diversification, which means that they are more vulnerable to negative triggers and downturns in the market. Beginner investors are typically advised to build a diversified portfolio to reduce risk, which is contrary to the nature of thematic funds.

Finally, investing in thematic funds requires careful timing. It is crucial to enter and exit the investment at the right time to maximize returns. Beginner investors may struggle with this aspect, as it requires a deep understanding of market trends and the ability to make timely decisions.

In conclusion, while thematic funds can offer attractive opportunities, they are not suitable for beginner investors due to the high level of risk, complexity, and long-term commitment involved. Beginner investors should instead focus on building a diversified portfolio and gaining experience in the market before considering thematic investments.

They are less diversified than other funds

Thematic funds are less diversified than other funds. While they are more diversified than sector funds, they are still more concentrated than diversified equity funds. This is because they are tied to a specific theme and can only invest in companies and sectors that are related to that theme. For example, a fund with an ESG theme will invest in companies that have performed well in terms of environmental, social, and corporate governance factors, but these companies could be from various sectors. This means that if one sector underperforms, it will not negatively impact the entire portfolio. However, if the theme does not play out as expected, there is a high risk of losses.

Thematic funds are considered one of the riskiest categories of mutual funds. This is because the scope of investment opportunities is restricted to the chosen theme. For example, a fund with an infrastructure theme will invest in companies related to steel, cement, and construction. If, for some reason, the infrastructure sector does not perform well, the fund's performance will be impacted.

Additionally, thematic funds may take a long time to play out and may not yield good results immediately. It can take many years for a theme to reach its full potential, and there is a risk that it may take longer than expected or may not play out at all. For example, the potential of the software industry was known in the 1980s, but it took another 20 years for it to attain critical mass and become a meaningful investment theme.

Due to the concentration risk and the potential for high losses, it is recommended that investors have a diversified portfolio of regular funds before investing in thematic funds. Thematic funds are suitable for investors with a high-risk appetite and a good understanding of the chosen theme and its potential. It is also important to monitor the theme closely and be prepared to make adjustments if needed.

They can be a good option for savvy investors

Thematic funds can be a good option for savvy investors, but they are not without their risks. These funds are susceptible to market movements and lack diversification, so they are generally not recommended for small or beginner investors. However, for investors with a high-risk appetite who are well-informed and evolved, thematic funds can offer some benefits.

One advantage of thematic funds is that they allow investors to pursue market exposure to specific ideas or themes. For example, a fund with a particular theme, such as infrastructure, will invest in companies from different sectors that are related to that theme, such as steel, cement, and construction. This provides some amount of diversification, as the fund invests in line with a theme that may include stocks from various sectors. For instance, a fund with a manufacturing theme might invest in companies from construction, chemical, engineering, and other industries. So, even if one sector is not performing well, the other sectors can help protect the portfolio from significant losses.

Another benefit of thematic funds is the potential for market-beating returns if the chosen theme performs well. Thematic funds can provide outstanding returns for investors who are able to correctly identify a successful theme. However, getting the theme right requires monitoring and following news and headlines regularly. Additionally, some themes may take a long time to play out, and there is a risk that they may not materialise as expected.

When considering thematic funds, it is important to keep in mind the risks involved. These funds are highly concentrated, which can increase portfolio risk. They are also susceptible to negative triggers, such as government decisions or geopolitical events, which can impact the performance of the theme. As such, investors might need to dedicate more time to monitoring and managing their investments in thematic funds.

In conclusion, while thematic funds may work for savvy investors, it is crucial to carefully consider the risks and potential drawbacks before investing. These funds are generally recommended for investors with a high-risk appetite, a long-term investment horizon, and a good understanding of different sectors and market trends.

Frequently asked questions