These Thematic Mutual Funds Offered Over 50% Returns In 1 Year. Should You Invest in Them?

Notably, the Sector/Thematic Fund category attracted inflows worth Rs 46,139 crore in FY 2023-24, the highest across all fund categories, according to data from the Association of Mutual Funds in India (AMFI).

As per the more recent AMFI data of May 2024, the Sector/Thematic Fund category of equity mutual funds received record high inflows worth Rs 19,213 crore. This included the new fund offer of HDFC Manufacturing Fund which mobilised Rs 9,563 crore.

The number of folios in the Sector/Thematic Fund category too have risen substantially from 1.3 crore as of May 2023 to 2.1 crore as of May 2024.

In this article, find out which Thematic Funds turned out to be top-performing schemes, the reason behind the rally, and whether you should consider investing in them.

What are Thematic Funds?

Thematic Funds are equity-oriented mutual funds that invest a major portion of their assets in stocks belonging to a particular theme such as manufacturing, PSU, consumption, EV revolution, green energy, etc. These funds are usually launched with an aim to capitalise on trends that are expected to outperform the market over the medium to long run.

As per SEBI's mandate, these funds are required to invest at least 80% of their assets in stocks of companies within the targeted theme. For instance, a PSU-themed mutual fund will invest predominantly in public sector companies such as SBI, NTPC, Power Grid Corporation, Coal India, etc.

Thematic Funds have the flexibility to choose stocks across market caps and industries, allowing them greater scope to identify high-potential opportunities.

Why have Thematic Funds turned appealing?

Various Thematic Funds have delivered stunning returns in the last 1 year. During this period, 20 Thematic Funds recorded returns of 50% or more, in absolute terms, as of June 20, 2024. The top performing Thematic Fund viz. HDFC Defence Fund grew by a whopping 137%. PSU-themed mutual funds were the other top performers with several schemes such as SBI PSU Fund, Invesco India PSU Equity Fund, Aditya Birla SL PSU Equity Fund, and ICICI Pru PSU Equity Fund rallying between 85-100%. Additionally, Business Cycle Funds and Manufacturing Funds have also registered significant growth in their NAVs.

Evidently, Thematic Funds focusing on key economic segments such as manufacturing, engineering, infrastructure, and energy have done well. Stocks in these segments have gained immensely in the last couple of years on the back of the government's infrastructure and capex push and reform initiatives such as 'Make in India'. Moreover, India's robust economic growth and healthy corporate balance sheet have resulted in a stellar rally for most stocks across the market segments.

The superior performance in these segments drew the attention of investors to mutual funds targeting investments in them as several diversified equity funds such as Large Cap Funds, Mid Cap Funds, and Flexi Cap Funds, etc. carry low weightage to these stocks/industries. Notably, for the Thematic categories mutual fund houses can launch numerous funds targeting different market segments. Thus, a sustained broad-based rally in the Indian equity market and the lure of new fund houses focusing on themes that have recently gained momentum resulted in Thematic Funds gaining traction.

Will Thematic Funds continue to shine?

Thematic Funds have high return potential due to the concentration of the portfolio towards a set of stocks that are expected to do well. However, it is important to note that no particular theme can turn out to be a multibagger year after year. Each theme undergoes cycles of outperformance and underperformance depending on the behaviour of the underlying drivers of growth such as government policies, demand conditions, input prices, etc.

Thus, it is possible that by the time one invests in a Thematic Fund, the underlying theme may have already run its course, leaving little room for further upside.

If the underlying theme/market segment falls out of favour following a period of outperformance, it may not bounce back quickly. For instance, PSU stocks in India were out of favour for over a decade, testing investors' patience, before they finally made a comeback a couple of years ago. Moreover, unlike diversified equity funds, the fund managers do not have much leeway to shift the portfolio away from underperforming themes.

Due to the concentrated nature of a Thematic Fund's portfolio, the downside risk can be relatively high during uncertain and highly volatile market conditions.

So, while Thematic Funds may continue to deliver positive results over the long run, it will not be without risks.

Besides, many of the aforementioned top-performing Thematic Funds do not have a long-term track record having been recently launched. Therefore, investing in them based on short-term returns may not be prudent as the past performance may not repeat in the future.

What should investors do?

Thematic Funds are high risk - high returns investment propositions making them suitable only for aggressive investors. Remember that returns in Thematic Funds can swing from thrilling highs to dangerous lows. This highlights that one should avoid the mistake of investing in a Thematic Fund simply because it had a great run in the recent past.

Most investors would be better off avoiding Thematic and Sectoral Funds. They should instead stick to maintaining a well-diversified portfolio of equity mutual funds that align with an individual's financial goals, risk appetite, and investment horizon. This will allow them to limit instances of severe market drawdowns and earn consistent returns across market phases.

Only those investors who are confident of the growth prospects of a particular theme and are well aware of the risks involved may consider investing some portion in them, ideally limiting the overall allocation in the category to under 15% of the equity portfolio. They may consider including Thematic Funds to gain exposure to certain niche/emerging segments of the market that are not typically covered by traditional mutual funds.

Watch this video to know about the biggest mistake mutual fund investors make and how to avoid them:

Note: This write up is for information purpose and does not constitute any kind of investment advice or a recommendation to Buy / Hold / Sell a fund. Returns mentioned herein are in no way a guarantee or promise of future returns. As an investor, you need to pick the right fund to meet your financial goals. If you are not sure about your risk appetite, do consult your investment consultant/advisor. Mutual Fund Investments are subject to market risks, read all scheme related documents carefully. Registration granted by SEBI, Membership of BASL and certification from NISM no way guarantee performance of the intermediary or provide any assurance of returns to investors.

We are on Telegram! Join thousands of like-minded investors and our editors right now.

DIVYA GROVER is the co-editor for FundSelect, the flagship research service of PersonalFN. She is also the co-editor of DebtSelect. Divya is an avid reader which helps her in analysing industry trends and producing insightful articles for PersonalFN’s popular newsletter – Daily Wealth letter, read by over 1.5 lakh subscribers.
Divya joined PersonalFN in 2019 and has since then used stringent quantitative and qualitative parameters to analyse funds to provide honest and unbiased research to investors. She endeavours to enable investors to make an informed investment decision and thereby safeguard their wealth.

Disclaimer: Investment in securities market are subject to market risks, read all the related documents carefully before investing.
This article is for information purposes only and is not meant to influence your investment decisions. It should not be treated as a mutual fund recommendation or advice to make an investment decision in the above-mentioned schemes.