Why Thematic Funds Are Not Solid Long-Term Investment Bets    Jul 08, 2016

One of the salient features of mutual funds is diversification. But there are exceptions here as well. Thematic funds are one such kind of funds which invest in stocks from one particular common theme.

Thematic mutual funds are growth-oriented equity schemes that aim at capital appreciation by investing in a set of say 3-4 sectors that are closely related to one particular theme. For example, funds like infrastructure funds will invest in equities of construction companies, cement companies, steel companies and other companies related to infrastructure.

There are many other thematic funds: Banking & Financial Services Sector, PSU, Power & Energy, FMCG, Pharma, MNC, Media & Entertainment, IT, and so on. Their performance is closely linked to how well the theme is performing. The economic policies framed by the Government also have a bearing on such funds. For example, the monetary policy stance of the Central bank has a bearing on Banking & Financial Services Funds.

Thus it becomes imperative to understand and analyses the future prospects of the theme or sector. Mind you, past performance is not indicative of its future performance.

Here are few reasons that are linked to the way thematic funds have fared…

Report Card: Thematic / Sector Funds vs. Diversified Equity Funds
Category 1 Year 3 Year 5 Year Sharpe Ratio SD Annualised Portfolio Turnover Expense Ratio
Infrastructure Funds 25.88 13.69 10.2 3.21 9.65 115.71 2.43
Banking & Financial Services Funds 0.06 14.94 10.08 1.49 11.72 302.21 2.5
Energy & Power Funds 12.97 14.32 10.14 2.35 10.69 208.96 2.47
FMCG Funds 6.52 14.63 10.11 1.92 11.2 255.59 2.48
Diversified Equity Funds 4.53 21.49 13.53 4.42 1.88 226.31 2.4
(NAV data is as on July 05, 2016. Standard Deviation and Sharpe ratio is calculated over a 3-Yr period. Risk-free rate is assumed to be 7.38%)
*Category average has been calculated taking into account the peers above
(Source: ACE MF, PersonalFN Research)

The Indian economy has been one of the fastest growing economies in the world. And in order to sustain high growth figures, robust infrastructure is imperative to remove the supply side bottlenecks. Due to various reformative measures taken by the Government, this sector has performed well in the last one year. All these factors accelerated the pace of wealth creation of these funds, albeit over the long-term i.e. over a 5-year period. They aren’t very aspiring barring a few funds due deep rooted graft affecting infrastructure development in true sense.

Likewise, in case of, banking & financial services sector funds, growing NPAs (Non-performing Assets) and slower credit off-take amidst RBI’s pro-inflation monetary stance has been a factor that has played out on the portfolio of such funds, except a few which have managed to clock decent returns.

Energy and Power Sector funds have an average of 8.97 standard deviation and its Sharpe Ratio is 2.35. Power plays an important role in the development of any economy and supports the whole infrastructure development. India’s power system is 5th largest in the world. But still the demand for power remains insatiable and there is lot of scope for future growth. Similarly, consumer durables sector is expected to grow by $ 20.20 billion by 2020. This sector has been consistently performing well as the purchasing power of the urban and rural population is increasing. But the sector as whole is for people who have good risk appetite.

It is clear from the above table that in the long-term diversified equity funds have outperformed. Their Standard Deviation (SD = risk measure) are also low as compared to the thematic funds. Fund managers take advantage of different market cycles and book profits. Hence they have broader investment opportunities available.

Hence if you find returns of a particular theme based fund attractive, you ought to do a thorough analysis of its future. If a particular industry has already passed the mature phase of life-cycle, the probability of the funds generating super-normal profits is less. On the contrary, if it is still in the growing phase, the funds are expected to perform well. Nonetheless, there is always a huge bag of risks involved because of Government economic policies and global uncertainty.

Many a times, there is no proper benchmark for theme based funds. For example, a fund with focus on rural development cannot have a benchmark such as Nifty 500. If a thematic fund is benchmarked with any other generic benchmark, then the comparative analysis would not hold weight. Many thematic funds have this issue.

To Sum up:
Unlike diversified funds, thematic funds or sector funds concentrate on only one theme / sector. Thus, the portfolio concentration makes them a very high risk-high return investment proposition vis-à-vis diversified equity funds invest that hold the mandate to invest across sectors and various market capitalizations (where by the risk is reduced).

Although many mutual fund distributors promote thematic / sector funds as the necessary ‘salt & pepper’ to one’s ideal investment recipe, at PersonalFN, we believe they’re not meant for the faint-hearted. Only those who have built a well-diversified portfolio of diversified funds to address to their long-term financial goals, have a very high risk appetite, and an investment horizon of at least five years may consider investing in thematic / sector funds recognising the risks and potential of the respective theme / sector. There’s no point getting lured by short-term data which can be misleading for the long-term objective of wealth creation.

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Jul 10, 2018


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