When it comes to mutual funds, you’ve probably heard about large-cap, mid-cap, or debt funds. But there’s another category of funds that often grabs headlines: thematic mutual funds.
These funds focus on investing in specific themes, such as defence, electric vehicles (EVs), or clean energy. The idea is simple: if you believe a particular theme or idea is poised for significant growth in the coming years, a thematic fund allows you to bet on that theme.
But is this strategy suitable for everyone? Should you invest in thematic mutual funds? Let’s find out.
Estimated read time: 4 minutes and 57 seconds
Was this blog shared with you? You can subscribe to our personal finance newsletter to receive such insightful articles directly to your inbox!
Buckle up. Here we go!
What Are Thematic Mutual Funds?
Imagine you’re at a buffet. Instead of trying everything, you decide to stick to just Italian dishes. That’s essentially what a thematic mutual fund does – it invests in stocks based on a specific theme or idea, rather than spreading investments across the broader market.
These themes could be:
- Technology (like artificial intelligence or cloud computing)
- Electric vehicles
- Clean energy
- Defence
- Digital India
- Manufacturing
Unlike sectoral funds, which focus on a single sector (such as banking or pharmaceuticals), thematic funds invest across sectors that align with a particular investment theme.
For example, a “Digital India” thematic fund might invest in technology companies, digital payment platforms, and even retail businesses that are shifting toward e-commerce.
A thematic fund’s portfolio is built around a particular narrative. If you believe in a long-term trend—say, the transition to renewable energy or the rise of electric vehicles—a thematic mutual fund focusing on clean energy or green technology might seem appealing.
However, with greater focus comes greater risk.
These funds are highly concentrated, meaning you could see impressive returns if the theme or idea does well. But if the theme faces challenges, the downside risk is equally high.
Factors to Consider Before Investing in Thematic Funds
If you are thinking about investing in thematic mutual funds, here are a few factors to consider before diving in:
- Understanding the Theme: The first and most critical factor is understanding the theme in which you are investing. For instance, if you are considering a fund based on electric vehicles (EVs), you need to assess whether the EV industry is truly on a long-term growth path. Research the factors driving the theme—are governments pushing for electric mobility? Are major car companies switching to EV production? Only if the answers align with your belief in the theme, should you consider the fund.
- Timing and Economic Cycles: The success of thematic funds is closely tied to economic cycles. For example, during a bull market, certain themes like consumer discretionary or technology may do well. On the flip side, during a recession, sectors like infrastructure or financial services may struggle. Timing your entry into a thematic fund is crucial, as investing at the peak of the theme’s popularity could lead to underperformance when the hype subsides.
- Concentration Risk: Thematic funds have a concentrated portfolio, which increases risk. Unlike diversified equity funds that spread your money across multiple sectors, a thematic fund puts most of its eggs in one basket. If the theme underperforms, so does your portfolio. This makes thematic funds riskier than other types of mutual funds.
- Long-Term Viability of the Theme: Ask yourself: Will this theme continue to be relevant in the next 10, 15, or 20 years? Themes like clean energy or technology may have strong long-term growth prospects because of global trends like sustainability or digital transformation. But others may fade over time. The success of your investment depends on the long-term viability of the chosen theme.
- Fund Manager’s Expertise: Not all thematic funds are created equal. The skill of the fund manager plays a crucial role in selecting the right companies at the right time within the theme. Even if the theme is strong, poor stock selection could lead to suboptimal performance. Check the track record of the fund manager and their experience in navigating market cycles.
- Expense Ratio: Thematic funds often come with higher expense ratios because of the specialized research involved in picking stocks aligned with the theme. Before investing, check if the potential returns justify the higher expenses. Compare the expense ratio of the thematic fund with other mutual funds and ensure you’re not overpaying for underperformance.
How Did the Thematic Funds Perform Historically?
The performance of thematic mutual funds varies significantly depending on the theme, the economic cycle, and the timing of investment. Some thematic funds have delivered strong returns during periods when their specific theme was in favour. For example:
- Technology-focused funds saw excellent performance during the digital revolution and even the COVID-19 pandemic, where tech companies led the market rally.
- Healthcare thematic funds benefited during the pandemic when there was a surge in demand for pharmaceutical companies and health tech.
However, performance is highly cyclical. Themes like infrastructure or real estate, which were once hot, have underperformed during certain periods, especially during economic slowdowns. An infrastructure-focused fund may have performed well during government spending on projects, but during times of fiscal tightening, these funds could lag behind.
And from time to time we have seen that it is almost impossible to time the market perfectly without being lucky. So let’s take a pragmatic approach to analyse thematic mutual funds.
Let’s analyse the performance of below top funds against benchmark indexes
- ICICI Prudential India Opportunities Fund
- Tata Digital India Fund
- ICICI Prudential Business Cycle Fund
These funds are selected based on AUM above ₹10,000 cr and different themes.
As you can see in the above infographic, these thematic funds do beat their benchmark but fail to or are unable to generate any extraordinary alpha when compared to the Midcap and Smallcap index.
We are comparing the returns of thematic funds with midcap and smallcap indexes because thematic funds are riskier than them. So thematic funds should provide additional returns for the extra risk, right?
Therefore, we don’t find the returns of thematic funds satisfactory enough to take such a high risk.
However, many investors want to have some kind of exposure towards a particular theme in their portfolio. If you are one of those, before investing consider the below factors.
When Should You Avoid Investing in Thematic Funds?
Stay away from thematic funds if:
1. You’re a New Investor:
- First, build a core portfolio with diversified equity funds
- Master the basics before exploring themes
2. You Can’t Handle High Volatility:
- Thematic funds can see sharp ups and downs
- If market swings keep you up at night, stick to broader market funds
3. The Theme is Already Too Popular:
- When auto rickshaw drivers start giving tips about a particular theme, it’s probably too late
- Remember: Buy the theme before it becomes mainstream
4. You Have a Short Investment Horizon:
- If you need the money within 3-5 years
- Thematic funds need time to play out their story
Final Thoughts
Thematic mutual funds can offer exciting opportunities for those who are confident in a particular theme or trend. However, they are not without risks. Their performance is highly dependent on the success of the specific theme, making them more volatile and riskier than diversified mutual funds.
For a beginner, it’s essential to understand both the potential and the risks before committing to thematic funds.
If you’re new to investing, it might be better to first build a solid foundation with diversified mutual funds or index funds before considering thematic funds.
However, if you have the conviction and long-term horizon to back a theme you strongly believe in, and you can stomach the ups and downs, thematic funds could be an interesting addition to your portfolio.
In general, our suggestion would be to stay away from thematic funds as their historical performance hasn’t been great unless you get lucky and time your entry and exit perfectly. It seems like a marketing gimmick wave these AMCs ride upon to charge high expense ratios and earn more.
Share these insights with your buddies.
Still Curious?
If you are like us, who likes to analyse a little more or check out content in different formats, well you are in luck. Below you can find some suitable content we found.
Freefincal – Why Thematic/Sectoral Mutual Funds Are Not Worth Your Investment
PersonalFN – Thematic Funds Become Market Leaders with Record-High AUM Growth
ET Money – Thematic and sectoral funds | Should you invest in them based on past performance
Note: We don’t have any affiliation with them. We are sharing links only for educational purposes. The opinions expressed by them belong solely to them and do not reflect the views of Vrid.
