Many people begin their investment journey with mutual funds because they offer a simple way to invest in the financial markets. However, selecting the right mutual fund can be challenging due to the wide range of options based on asset class, risk level, and market capitalisation. Among these, thematic funds are suitable for investors who want to invest in a specific sector, trend, or long-term theme. These funds focus on particular investment ideas rather than the broader market. This article explains what thematic funds are, how they work, and the key benefits and risks you should understand before investing.
What are thematic mutual funds?
When investing, you can choose from different strategies based on your financial goals. thematic mutual funds are one such option. These are open-ended equity mutual funds that invest in companies linked to a specific investment theme, such as technology, healthcare or infrastructure. Their performance depends on how the chosen theme grows over time. Understanding how thematic mutual funds work can help you decide if they suit your investment objectives and risk appetite. This guide explains what thematic mutual funds are, how they work, their key benefits, who can invest in them, important factors to consider, their taxation, and some of the top-performing thematic mutual funds.
How do thematic funds work?
Thematic funds operate by identifying and investing a minimum of 80% in sectors or themes expected to experience significant growth or transformation in the future. Fund managers analyse market trends, technological advancements, regulatory changes, and consumer behaviour to identify these themes. Once identified, the fund invests in companies related to the chosen theme or sector, aiming to benefit from their growth potential.
Key features of thematic funds
1. Relative Diversification:
Thematic funds provide a broader scope for diversification compared to sectoral funds. They invest in stocks across multiple sectors, offering investors exposure to diverse industries within a single fund.
2. Potential for Lucrative Returns:
By selecting a specific theme and timing market entry effectively, investors have the potential to reap significant returns. Thematic funds capitalise on emerging trends and sectors, presenting opportunities for profitable investments.
3. Varied Market Capitalisation:
Thematic funds offer flexibility in terms of market capitalisation. Investors can allocate funds across companies of different sizes, including large-cap, mid-cap, and small-cap stocks, based on the chosen thematic focus.
Benefits of investing in thematic funds
Listed below are some benefits of investing in thematic mutual funds:
- Diversification: Thematic funds offer investors exposure to specific sectors or themes that may not be available in traditional diversified equity funds. By investing in thematic funds, investors can diversify their portfolios and reduce overall investment risk.
- Potential for market-beating returns: Thematic funds focus on niche sectors or emerging trends that have the potential to deliver higher returns compared to broader market indices. By targeting sectors with growth potential, thematic funds may outperform the broader market over the long term.
Who should invest in thematic funds?
Given below is a list of which type of investor should invest in thematic mutual funds:
- Investors with high-risk appetite: Thematic funds are suitable for investors willing to take higher risks in exchange for the potential of higher returns. Since these funds focus on specific themes or sectors, they may experience higher volatility compared to diversified equity funds.
- Investors seeking long-term returns: Thematic funds are ideal for investors with a long-term investment horizon. These funds require patience and conviction, as the themes or sectors they invest in may take time to materialise and generate significant returns.
- Well-informed and evolved investors: Thematic funds are best suited for investors who understand the dynamics of specific sectors or themes and can evaluate their growth prospects effectively. Investors should stay informed about market trends and economic developments to make informed investment decisions in thematic funds.
Risks associated with thematic funds
Although the advantages of engaging in thematic funds might seem enticing, it's essential to grasp the associated risks, particularly their tendency towards concentrated risk exposure.
Thematic funds carry similar risks to other types of mutual funds, including susceptibility to interest rate fluctuations, absence of guaranteed returns, and the potential for the principal amount to decline due to market volatility, shifts in government policies, and political developments. These risks stem directly from the volatility of the equity market and include the following:
- Risk of total loss: Investments in thematic and related securities may result in a complete loss of the principal amount.
- Price risk: Market conditions can cause daily fluctuations in prices.
- Liquidity risk: Settlement periods may unexpectedly prolong, and selling may be constrained due to the overall trading volume of specific stocks in the portfolio. This constraint can lead to potential losses and a decrease in the scheme's value.
- Event risk: Any unforeseen or adverse event affecting an industry or company in which the mutual fund is invested can contribute to price risk.
Difference between thematic funds and sector funds
| Feature | Thematic Funds | Sector Funds |
| Investment focus | Target a broad theme or trend across various sectors. (e.g., healthcare, clean energy, technology disruption) | Focus on a specific industry or sector. (e.g., banking, pharmaceuticals, information technology) |
| Underlying assets | Invest in companies from different sectors that align with the chosen theme. | Primarily invest in companies belonging to a single, pre-defined industry. |
| Diversification | Generally considered more diversified due to exposure across multiple sectors. | Less diversified, potentially leading to higher risk if the chosen sector underperforms. |
| Risk profile | Risk level can vary depending on the theme's underlying assets, but generally considered moderately risky. | Risk tends to be higher due to concentration in a single industry. |
| Investment horizon | Often suitable for long-term investors who believe in the theme's long-term potential. | May be suitable for medium to long-term investors with a strong understanding of the chosen sector. |
| Example | A healthcare thematic fund might invest in pharmaceutical companies, medical device manufacturers, and healthcare IT firms. | A banking sector fund would primarily invest in shares of various public and private banks. |
Points to consider before investing in thematic funds
Before investing in thematic funds, investors should consider the following points:
- Research and understand the theme: Investors should thoroughly research and understand the theme or sector the thematic fund focuses on. Understanding the underlying factors driving growth in the chosen theme is essential for making informed investment decisions.
- Evaluate fund manager expertise: Assess the track record and expertise of the fund manager managing the thematic fund. A skilled and experienced fund manager can effectively identify investment opportunities and navigate market fluctuations.
- clarify investment goals: Before delving into thematic funds, it is imperative to define your investment objectives clearly. Achieving optimal returns from thematic funds typically requires a long-term investment horizon of over 5 years. This extended timeframe aligns with the nature of thematic investments, which often require significant time to reach their peak potential. Therefore, investors should align their goals with long-term aspirations such as early retirement or funding a child's education.
- Assess investment risks: While the allure of thematic funds may be strong, it's crucial to acknowledge the associated risks. Thematic funds are inherently high-risk vehicles, making them less suitable for novice investors. Key risks to consider include:
- Semi-diversified portfolio: Thematic funds offer a degree of diversification, albeit less than multi-cap funds, as they focus on specific themes rather than various sectors. Consequently, the risk of simultaneous downturns in all holdings is higher compared to broader equity funds.
- Extended theme realisation periods: Investors should recognize that themes may take longer than anticipated to materialise. Despite optimistic projections, certain themes may require more time to yield substantial returns.
- Evaluate expense ratios: Investors should be cognizant of the expenses associated with thematic funds, particularly the expense ratio. This fee, charged by asset management companies (AMCs), covers administrative and operational costs such as fund management fees and marketing expenses. It's essential to understand these fees, as they directly impact overall returns and should be factored into investment decisions.
Taxation on thematic funds
The taxation on thematic mutual funds depends on how long you hold your investment. Since most thematic funds invest mainly in equities, they follow equity mutual fund tax rules. If you sell your units within 12 months, any profit is treated as Short-Term Capital Gains (STCG) and taxed at 20%. If you sell after holding them for more than 12 months, the profit is treated as Long-Term Capital Gains (LTCG) and taxed at 12.5%. These revised tax rates apply under the latest rules. Before investing, consider both the potential returns and the tax impact on your overall investment goals.
How can you invest in thematic funds on the Bajaj Broking website?
- Step 1: Visit the Bajaj Broking website or download the app from Google Play Store or App Store
- Step 2: Navigate to 'Investments' and click on 'All Investments' on the home page
- Step 3: Click on 'Mutual Funds' icon
- Step 4: Click on 'Explore Funds'. You will be redirected to the mutual funds listing page
- Step 5: Filter by scheme type, risk appetite, returns, etc. or choose from the top performing funds list
- Step 6: All the mutual funds of the particular category will be listed, along with the minimum investment amount, annualised return, and rating
- Step 7: Click on 'Invest Now'
- Step 8: Enter your mobile number and sign in using the OTP
- Step 9: Verify your details using your PAN, date of birth. If your KYC is not complete, then you will have to upload your address proof and record a video
- Step 10: Enter your bank account details
- Step 11: Upload your signature and provide some additional details to continue
- Step 12: Choose and select the mutual fund that you want to invest in
- Step 13: Choose whether you want to invest as SIP or lumpsum and enter the investment amount. Click on ‘Invest Now’
- Step 14: Select your payment mode i.e., net banking, UPI, NEFT/ RTGS
- Step 15: Once your payment is done, the investment will be complete
Your investment will start reflecting in your portfolio within 2-3 working days.
Conclusion
Thematic funds offer investors an opportunity to capitalise on specific market trends and emerging themes. While these funds can potentially deliver market-beating returns, they also involve higher risk due to their focused investment approach. Investors should carefully evaluate their risk tolerance, investment goals, and understanding of thematic themes before investing in thematic funds. By conducting thorough research and seeking professional advice, investors can make informed decisions and potentially benefit from the growth opportunities offered by thematic funds.
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