Thematic funds: Should you invest?

Thematic funds are equity mutual funds that invest in stocks tied to a theme such as multi-sector, international exposure, export-oriented, rural India, etc. With markets showing signs of consolidation after the recent bout of volatility, a lot of investors may be planning to shift or diversify towards thematic funds.

We reached out to a few experts to understand when is the right time to invest in thematic funds and the pros and cons of putting your hard-earned money.

For starters, investors in thematic funds must clearly understand that it may take a long gestation period and may not yield good results immediately, said Anup Bansal, Chief Investment Officer at Scripbox.

“Unlike sector funds which tend to be cyclical and therefore have timing risk, thematics carry higher opportunity cost as the theme may not play out for a long time post investing in the theme. For example, the alternative energy theme or infra theme has not done well so far even though as a theme they were identified 10 to 15 years back,” Bansal told CNBC-TV18.com.

Some of the themes may appear as unique themes but could already be a major component in a well-diversified mutual fund and therefore, further investment in a broad-based theme creates an overlap leading to lesser diversification, he added.

For example, Bansal said that ESG as a theme may already be covered because all futuristic companies have to score high on ESG parameters and therefore a mutual fund manager of a non-thematic fund may run his selections including ESG criteria.

Does that mean one should completely avoid investing in thematic funds?

Answering this, Prateek Singh, Founder and CEO, LearnApp.com said that a beginner investor shouldn’t invest in thematic funds.

“A beginner investor, investing in a particular sector that is a theme, maybe completely wrong, and maybe investing at the wrong time of the cycle. A few beginner investors may select an incorrect theme and see the stock market rise but not their stocks. Therefore, for beginner traders, thematic funds do not make sense,” Singh told CNBC-TV18.com.

Asset classes such as equity, bonds, gold etc. move in cycles, hence they sometimes do well and vice-a-versa. No one knows when these cycles come and go, however, all we know is that these assets move in cycles.

For slightly more experienced investors who already have a portfolio that is diversified and have invested in an index fund or already have an investing strategy, Singh said, can allocate a small portion of the capital to thematic investing.

Concurring with Singh's views, Bansal of Scripbox said that it may be better to have a well-diversified mutual fund portfolio in the home country portfolio and supplement that with a thematic investment in a foreign country portfolio.

“Developed countries offer good themes like green technologies, biotech, climate change and importantly, in ETF formats. Preferably, passive investment in themes is a good combination with active diversified funds," Bansal said.

"In conclusion, if a theme is mainstream then it would be covered under a well-diversified mutual fund portfolio. If the theme is futuristic then it is better to watch and then allocate higher weights to the theme as it could take a long time to actually play out. Investors would need to be patiently invested for a very long time in futuristic themes. Also, one should have a good understanding of the theme and its potential before investing. Since some themes may or may not work out, investors should put a rigorous monitoring and review process to take post-investment decisions of buy more, hold or exit," he suggested.