Thematic Mutual Funds as New Investment Trend for Retail Investors; Should You Invest or Not?
Thematic mutual funds have gained significant attention in recent years, surpassing traditional categories like small-cap, mid-cap and large-cap funds in popularity. These funds focus on specific themes such as technology, healthcare or clean energy, offering investors a chance to capitalize on potential growth within certain sectors. Asset management companies (AMCs) have been quick to respond, launching numerous thematic and sectoral funds, including the Bank of India Business Cycle Fund and the Invesco India Manufacturing Fund.
The Mutual Fund industry in India touched fresh highs in August 2024. According to data released by the Association of Mutual Funds in India, the AUM of the industry grew to an impressive Rs.66.70 lakh crore, resulting in a rise in the number of Indian investors choosing mutual funds as an investment avenue. A key factor for such growth has to do with rising thematic funds at 179 outnumber conventional categories.
Thematic mutual funds are those funds that invest in companies or stocks based on a specific theme. A thematic fund can target infrastructural sectors, electric vehicle sectors, or renewable energy sectors. It tries to capture sector-specific growth trends, which, over some time, may outperform the broader market. It is different from diversified mutual funds that spread their investments across different industries. In contrast, thematic funds would narrow down their exposures to a single sector or theme and, as such, invest in companies that align with those themes.
For example, an electric vehicle-themed fund would be invested in companies dealing with EV manufacturing, battery production, or related technologies.
Fund houses are increasingly adopting thematic funds to offer something new and different to investors. Strict guidelines by the Securities and Exchange Board of India limit the number of schemes an AMC can introduce in traditional categories such as large-cap, mid-cap, and small-cap funds. This is leading the AMCs to launch more thematic funds in order to attract investment.
The Thematic equity category reported an AUM of Rs.4.44 lakh crore in August 2024, which saw an inflow of Rs.18,117 crore. Thematic funds added Rs.10,202 crore in the NFO space during the month, which indicates strong demand. AMCs are trying to encash emerging trends and government policy announcements. Infrastructure, defence, electric vehicles, and manufacturing were some of the themes more talked about and leading the trend for the month due to policy thrust.
Thematic funds have a great potential for high returns, especially if the particular sector one invests in happens to do well. However, the flip side of such funds is that massive risks are involved with them. Sectors like defence, electric vehicles, and infrastructure have seen strong, sharp gains over the last few years on the back of increased government spending and friendly policies towards the sector. While all this might be very tempting to investors, inflating company valuations beyond recognition makes for highly expensive stocks, which may not hold good in the long run.
Most financial experts would recommend against putting all of one’s investment in a single sector. Diversification tends to be a lot safer, considering the associated risk is spread across a wide variety of industries, therefore reducing the consequences of any underperformance in one area.
The key risks associated with thematic funds are primarily related to a lack of diversification. While multi-cap or flexi-cap funds invest across different sectors, a thematic fund focuses on certain selected areas, and hence the risk of volatility sets in. In case the chosen theme does not turn out well, the investor may face significant losses.
Retail investors must make prudent judgments regarding the risks of thematic funds. Such a fund may have a very good return if the sector in which it has invested is booming, but a downturn in the sector might affect the entire portfolio since their investments are concentrated. A right mix of thematic funds with diversified mutual funds will help balance the portfolio while optimizing risk.
In short, thematic mutual funds are an excellent way to hop onto emerging trends for an investor. But they are far riskier because of their focused nature. For the large majority of retail investors, diversified equity funds remain a haven of safety, while thematic funds are to be entered at their own peril, provided they are balanced in a well-rounded portfolio.
