Thematic Mutual Fund: Risky But Rewarding

Thematic fund

When you go for shopping in a super market there are numbers of items accessible which you know and use frequently. There are also numerous items which you have never utilised and such items are added in your shopping baskets at times. Until you know which item is good fit for you, your shopping spree can turn into a hit and miss proposition costing you higher, may be even for the things which you never needed.

Likewise, the Mutual Funds industry has number of schemes on offering. While some are traditional equity schemes which retail investors are aware of and some are very specific like sectorial and thematic. So understanding and selecting the right sort of Mutual Fund scheme which suits your risk profile and final objective is vital or else this could result in a hit and miss proposition as well.

A large number of funds are launching on regular basis by Indian fund houses including a number of unique schemes, typically timing it to suit certain economic conditions. These unique schemes are famously known as ‘Thematic fund.’

A thematic fund is the one where the fund's goal is to deliver optimal returns by putting resources into stocks which qualify to belong within the particular theme. Basically, thematic mutual funds are growth oriented equity schemes which aim to achieve capital appreciation by investing in a set of stocks that are closely related to a particular theme. Various patterns have been utilised to shape a Thematic Fund. For instance, following the time when country’s Prime Minister Narendra Modi has pitched to industry ‘Make In India’ theme, the markets have gained excitement and many such schemes are launched to help investors to take advantage of the ‘Make In India’ theme. Aside from ‘Make in India,’ there are few other schemes which have utilised pattern to form thematic funds like ‘Digital India’ and ‘Rural India’.  In general, it is considered to be a top-down investment approach with a focus on broader, macroeconomic themes that a fund manager can use to identify strong companies.

One of the key tenets of thematic investing is ensuring that the secret embedded within any theme's underlying story isn't already out in the market and factored into the price. Instead of investing on a country, sector or cyclical basis, thematic investment diversification comes from the diametrically different nature of investment trends themselves.

Sectorial Funds and Thematic Fund

Numerous investors think that sectoral funds and thematic funds are similar in nature. But that is not the reality. Albeit one could draw some broad similarities, yet the scope of a thematic fund is typically wider. While, the sectoral mutual funds are those funds which restrict their investments to a particular segment or sector of the economy. Simply, the sector mutual funds are concentrated bets and aim to invest their entre corpus in one sector for example like banking fund, pharmaceuticals fund, real-estate fund etc. are called as sector funds. For example: Reliance Pharma Fund invests only in stocks of pharmaceuticals companies. SBI Banking Sector Fund will invest only in the banking stock. The objective here is to allow investors to make the most of specific industries or sectors which have strong growth potential.

On the other hand, the thematic funds are a kind of mutual funds that invest across the sectors related to the common theme. Unlike sector funds, the thematic funds are more diversified as the investments are concentrated in several sectors and not in a single sector. For example, an automobile thematic fund will invest in companies which may work in different industries, but are part of common theme like automobiles companies, auto ancillaries and petrochem, all related to the automobile sector.

Says Harshad Chetanwala, Head-Customer Delight, Quantum AMC,

“There is a thin line that separates thematic funds and sector funds. Thematic funds invest in line with an investment theme. For example, an infrastructure thematic fund might invest in shares of companies that are into infrastructure construction, infrastructure toll-collection, cement, steel, telecom, power etc. the investment is thus more broad-based than a sector fund that invests in only a specific sector. A Pharmaceuticals sector fund will invest in only shares of Pharmaceuticals - related companies”.

Note: * Top 10 performing funds return based on weighted avg of AUM size

Things to keep in mind: sectoral funds and thematic funds by nature are more prone to risk and volatility. However, from a risk point of view, a thematic fund carries less risk than a sectoral fund. The reason being the latter is focused on particular sectors. A sector fund performs very well when the sector in which it invests does well. But when that sector does badly, the sector fund falls the hardest due to lack of any kind of diversification. Since thematic funds are not a concentrated bet they can fall under the category of semi-diversified fund as they are little more diversified than sectoral fund and also they are less risky as compared to the sectoral funds. However, if we do a comparison between the diversified equity mutual fund and thematic mutual fund, the latter is risky as they have restrictions in their investment options and have to invest in particular theme even if that theme is not performing well. On the other hand, diversified funds have no such restrictions. Hence, this makes them a safe heave bet. However, According to Swarup Mohanty, “A well-managed fund can outperform diversified funds.”
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Flop show of thematic funds in past

Considering the past experience, as Issac Newton has quoted ‘What goes up must come down’ and this applied to thematic funs as well. Every theme has an expiry date and the nature of business cycles is such that every boom is eventually followed by a downturn. If you look at past, three classic episodes took place when there was the euphoria created by the markets for a particular theme and at a same time the mutual fund houses launched schemes based on that theme but it became only an illusion for investors.

“Investors should be very careful before investing in thematic fund because there is lot of risk involved. While investment in thematic fund is more broad based than sector fund one should understand that it is more narrow based than a diversified equity fund that allows to invest investor’s money across various sectors and themes,“ says Chetanwala.

First Episode: In the year 1999, information technology theme was in the seventh heaven. Considering the hype in this theme many of the AMCs came out with  information technology theme funds like Ecom Funds, Internet Opportunities Funds, etc. The hype was such for Information Technology Fund that every one wanted to invest in these themes and all the investors invested their hard-earned money with high hopes of turning their fortunes fast. However, a year later, the bubble of information technology got burst. The Information technology sector became a nightmare for investors as the sector witnessed a hefty correction during the year 2000 and it took years to witness turnaround in this theme.

Second Episode: During the year 2007-2008, the Indian economy was eyed as one of the fastest growing economies in the world and many thought it was a hotspot for investments and the theme which was in the limelight was ‘infrastructure’. Considering the trend and liking for this theme, many AMCs launched infrastructure theme funds and yet again it was well accepted by the investors as many reports were floating in the markets that for next 5-10 years, infrastructure would continue to outclass the other sectors or themes.  But the tide changed its course and the infrastructure related stocks saw a huge unwinding of long positions and these stock turned to laggards following the global economic crisis. These themes were worst affected and even today many infra based funds have not yet recovered. Investors learnt yet another lesson that the prospect which they had perceived for infrastructure in 2007-08 turned to illusion due to global meltdown.

Third Episode: In the year 2012, the yellow metal was the talk of the nation. For the initial year, gold funds continued to glitter. Now, gold exchange traded funds (ETFs) seem to have lost its sheen as investors pulled Rs 903 crore from this instrument in the last fiscal compared to an outflow of Rs 1,475 crore in the preceding financial year. In 2013-14, the funds witnessed outflow of Rs 2,293 crore. The asset base of gold funds dropped to Rs 6,346 crore in March 2016 from Rs 6,665 crore at the end of March 2015. Gold prices had a good run until 2012 and investors bought gold chasing the historical returns from gold. As gold prices crashed, investors were highly disappointed and hence, made an exit route from the gold.

There is a good lesson to learn from the above three episodes which have occurred in the past. The lesson is that it’s not necessarily which theme has worked in the past will continue to outperform in the future. Stock markets run in cycle and it has been observed in the past that every bull cycle is dominated by different set of themes. Hence, we need to pattern our investment in such a manner that we are not trapped at the top.

Having talked about the elements of thematic fund and the risk associated with the thematic fund. Now the next important question arises who can invest in thematic funds and how much one should take exposure to such funds?

Investing in mutual funds is undoubtedly a best long term investment approach. Investing into mutual funds through SIP approach is a well-known proved concept, however, selection of right mutual fund scheme is a tough decision. It has been seen in the past many of the investors face problems in selecting the right mutual fund to reach their financial goals. Mainly due to lack of awareness of schemes, investors are unable to identify the right mix of mutual fund schemes for their investment portfolio. This mistake results to not only in the loss of precious time but also some ends up with insufficient corpus for their financial goals. As a retail investor, one should look at the thematic funds to take advantage of turnaround in a particular theme. Thematic funds are good for an experienced investor who understands the theme, both in terms of what the potential is, what are the risks associated with the themes and seeks diversification in that theme. Besides, these funds can play a supporting role in a diversified portfolio by allowing investors to increase exposure to untapped sectors that may be under-represented in their portfolio.

Mohanty of Mirae Asset believes, “the allocation to all thematic funds put together should be of 10-15 per cent of the investors’ allocation. The number can vary bases on investor risk profile and investment time horizon. Investor should consult their financial advisor while finalising these allocations”. Remember, while these funds can be riskier than diversified funds, they also have the potential to provide superior returns. The key is to select the right theme and monitor their progress over the investment period.

Dialogue Box

Suggestions from Prashast Seth of IIFL MF, ”an investor investing in these funds need to ask himself the following questions that may be important to ascertain his profile. Below are the questions which will help to investor ascertain his profile

·        If you are investing in a thematic fund, do you know enough about the theme and believe it is a good time to invest?

·        Are you willing to closely track performance of the theme with regard to your funds?

·        Would you know when the theme looks overheated and move out?

·        Are you willing to book losses and exit if it becomes evident that theme is not going to revive in a hurry?

Once you have found answers to the above question, then only one should take exposure to thematic fund. “

Types of thematic funds - A closer look

We have explained features of the different types of thematic funds available in the Indian mutual fund market such as commodities, resources & energy, Indian consumption, infrastructure, MNC, PSU Shariah and dividend yield fund. They follow different investment strategies, seem somewhat diversified and have delivered notable returns during some cycles. The mutual funds industry has kept evolving itself to match with the trend and hence, going forward one should not be surprised with new thematic funds which you could not find in the categories mentioned below.

Commodities based thematic fund:

Inability to directly deal in commodities takes small investors to mutual funds that invest in commodities either directly or through stocks of commodity companies. In India, mutual funds can directly invest in only one commodity, gold. So, most commodity funds, except gold exchange-traded funds, either invest in shares of commodity companies or buy units of funds that invest in such companies. Such funds are designed to reflect the behaviour and performance of a diversified portfolio of companies representing the commodities segment which includes sectors like oil, petroleum products, cement, power, chemical, sugar, metals and mining.

Comparison of better performing schemes from Commodities Based Thematic Fund (NAV as of April 22, 2016)

Resources & Energy Fund:

Energy is a crucial input for India's development process. The need of the hour, therefore, is to meet the energy needs of all segments of India's population in the most efficient and cost-effective manner while ensuring long-term sustainability. Energy stocks have become one of the best long-term bargains where it seeks to provide long-term capital appreciation by investing of fund assets in common stock of companies primarily engaged in activities related to the energy industry. Companies engaged in energy related activities, including oil, gas, electricity, coal and new sources of energy.

Comparison of better performing schemes from Resources & Energy Fund (NAV as of 22nd April, 2016)

India Consumption Fund:

The Indian consumer sector is expected to grow by 13-14 per cent p.a. and may not be majorly impacted by the macroeconomic headwinds such as higher inflation and growth slowdown. This results in the consumption theme based schemes to generate balanced returns during various market cycles. These funds are designed to reflect the behaviour and performance of a diversified portfolio of companies representing the domestic consumption sector which includes sectors like consumer non-durables, healthcare, auto, telecom services, pharmaceuticals, hotels, media & entertainment, etc.
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Comparison of better performing schemes from India Consumption Fund

 (NAV as of April 22, 2016)

Infrastructure Thematic Fund

Infrastructure is said to be the tangible aspects such as roads, railways, transportation, electricity and so on which are indispensible to the day to day functioning of an economy. Infrastructure fund invest in the securities of companies engaged in infrastructure and infrastructure related sectors. The portfolio is well diversified across sectors, market capitalisation and between PSU and private companies. Fund houses invested in this fund could be directly linked to infrastructure such a construction or production of capital goods or indirectly benefit from sectors like banking and metal. Currently these funds are heavily tilted in their investments towards sectors like, auto & auto ancillaries, banking and financial services, consumer cyclical, telecom, constructions and project and petroleum and gas.

Comparison of better performing schemes from Infrastructure Thematic Fund

 (NAV as of April 22, 2016)

MNC funds

MNC funds invest in multinational firms listed here and also in stocks that have high Foreign Institutional Investor (FII) holdings. Despite the rich valuations of MNC companies, stocks in this space rallied well over the past few years because there was expectation that some of these might delist, after SEBI told the listed private sector companies needed a public shareholding of at least 25 per cent. They are more diversified than sector funds for one simple reason – they hold a basket of sectors. In addition, they hold a basket of both defensive (FMCG, pharma) and growth sectors (capital goods, engineering and auto) giving them an option to choose sectors based on market conditions. Most MNCs have strong cash balances, high dividend payout ratios, low debt‐to‐equity ratios and healthy return ratios.

Comparison of better performing schemes from MNC Fund (NAV as of April 22, 2016)

PSU Funds

PSU Funds invest primarily in equity related instruments of companies where the central / state government(s) have majority shareholding or management control or powers to appoint majority of directors. Within the PSU space, the scheme intends to focus on high-growth sectors like oil, gas, infrastructure, financials and utilities and the companies that offer the benefit of size and visibility. The scheme is suitable for the investors who are bullish on the PSU theme and think that PSU stocks can be a wealth creator in the longer run. As it is a thematic fund, it is meant for investors who have sizeable exposure to diversified funds and can consider it as an add-on to the core portfolio.

Comparison of better performing schemes from PSU Fund (NAV as of 22^nd April, 2016)

Shariah Funds

There are funds in India those invest in companies which are in compliance with the Shariah norms. Their investment mandates are based on the fundamentals of Shariah or Shariat, which are guided by the Islamic investment philosophy which invests in companies based on certain screening norms. They invest in the companies which are based on the principles of Shariah whereby, it is not permissible to acquire the shares of Companies providing financial services on interest like conventional banks, insurance companies or the companies involved in some other business not approved by Shariah, such as companies manufacturing, selling or offering liquors, meat, or involved in gambling, night club activities, pornography etc.

Comparison of better performing schemes from Shariah Fund (NAV as of 22^nd April, 2016)

Dividend Yield:

There are a number of ‘dividend yield’ equity funds, which aim to generate both regular income and capital appreciation by investing in high dividend yield stocks. They hold stocks that are available at attractive valuations due to the high dividends payout (the prices of the stocks correct once they pay out the dividend). These companies have stable businesses and have a history of consistent profitability. Considering the performance during the various cycles, dividend yields category managed to contain the falls well in against all the downturns compared to equity diversified category and the broader indices.

Comparison of better performing schemes from Dividend Yield Fund (NAV as of April 22, 2016 )

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What is an ideal investment time horizon to invest in thematic fund?

Swarup Mohanty-CEO-Mirae Asset Global Investments

This is a very important question. Investors should be able to gauge the relevant time horizon for investing in the theme and also exit if the theme is not relevant. For Eq: Many investors looked at past returns generated by Infrastructure Funds and invested in 2007. However, after the Lehman crisis the global economies are facing headwinds for growth and hence capex expenditure has been curtailed across economies including India. Also due to higher fiscal deficit and high debt burden, many infrastructure projects are stalled. Hence investors who invested in infrastructure funds have had bad investment experience. Hence time horizon and time period to invest are very important decisions for such funds.

Themes which are likely to outclass the benchmark indices in the coming years:

Most of the themes look promising at the current juncture. They look like opportunities for investors to earn higher returns. But we need to analyse first where does these thematic funds stand on risk parameters and which scheme should be included in your investments portfolio.

Following are the themes which look promising in coming years:

1.     Infrastructure Thematic Fund:

Infrastructure related stocks have undergone a huge correction since the year 2008 market crash. However, this sector looks attractive and likely to witness an up-tick in the coming years. The Indian government announced ‘Smart City 100’ mission. Under this scheme, selected cities would become smart cities by providing better infrastructure and other utilities. Significant increase in planned public-sector capital expenditure, couple with measures increase investment and financing in the private sector, will boost the infrastructure in India. Such infrastructure development is likely to provide enormous opportunities to companies which would be directly or indirectly involving in the infrastructure related work.

Infrastructure spending currently stands at 8 per cent of GDP and the aim is to increase this to 10 per cent. The projected investment in infrastructure in the 12th Plan (2012-17) is Rs 1 lakh crore with more than a third expected from the private sector. In the current budget the allocation to the infrastructure sector go up by Rs 70,000 crore in 2015-16 over last year. These initiatives pale when compared to China that spends about 11 per cent of its GDP on infrastructure development, as compared to 6 per cent of the GDP spent in India, one of the factors responsible for the competitiveness of its manufacturing sector.

The sector needs consolidation in policy framework due to progress is slow because of delays in decision-making and problems with land acquisition, while environmental clearances have added layers of complexity for investors trying to navigate India’s bureaucratic bylanes. But the government has given enough indications for transparency in environmental clearances and making land acquisition easier. It is hoped that the measures announced in the Budget would help kick-start activity in this sector with active participation of private players in the future.

2.     Indian Consumption Fund:

Urban consumption is already improving and visible in several indicators. Rural consumption, on the other hand, has borne the brunt of fiscal consolidation. Poor rains in the last couple of years have dampened rural sentiment. However, the worst for the rural belt appears to be behind us and a slow healing should add to overall consumption recovery for Indian in coming years. The Union Budget focused more on agriculture, farmer’s welfare, rural employment. As we are aware the rural consumption largely depends on a good monsoon and we have had 2 consecutive years of drought. The good news is that one can safely expect a good monsoon after 2 years of drought and this is backed by the recent reports by the Indian Meteorological Department (IMD) and Skymet, a private weather forecaster, predicted an above normal monsoon. The rural consumption story is not restricted to monsoon and higher agriculture output. The government has focused on the rural employment program in this budget and has also substantially expanded its spending on building infrastructure for the same. These are likely to put more money in the hands of rural people. Also the large success of the crop insurance scheme will go a long way in reducing the risk for farmers across India, adding to their incomes. The 7^th Pay Commission, it could provide a boost to consumer spending as well. Swarup Mohanty-CEO-Mirae Asset Global Investments is very positive on the ‘Consumption Theme’.  ‘He feels this theme will be prevalent for the next couple of decades, with Indian and Asian region leading the consumption growth story. He believes the consumption theme is driven by three main secular drivers 1. Demographics 2.Rising Middle Class and 3.Increasing Penetration.’

Conclusion:

The core portfolio of individual investors depends on his income, savings, risk appetite, returns expectations etc. In addition to pure investment parameters we have to identify financial goals/objectives that one wants to achieve. So an individual looking forward to invest in thematic funds, he needs to comprehend that thematic funds are risker in nature as compared to normal diversified fund, however, high risk yields high returns. According to Prashast Seth, “not more than 10-15 per cent capital should be allocated in thematic funds. Because it is difficult for an investor to study the theme which is likely to outperform and an investor face challenges like when to enter and get out of particular theme”. Hence, while investing in thematic fund its important to understand the business cycle. It can help investors identify inflexion points (i.e. when the economy or particular theme changes its direction), where the risk and the opportunities for higher return may have heightened. In the past it has been witnessed that investors have got the timing wrong while investing in thematic fund. For example, when the economy was booming infrastructure funds were doing very but thereafter it the performance of Infrastructure fund kept on sinking like Titanic. Hence, the investor should understand what is driving the current economy and what may cause the end of the current trend of the theme. In brief investor should understand the phase of business cycle and theme which are likely to perform when in that phase of the business cycle. 

Advice to investors, ‘as we have mentioned consumption and infrastructure sectors are likely to deliver a bright performance in the coming years, hence, investors can allocate 10-15 per cent of their investment in infrastructure and consumption theme funds to take advantage of uptrend in the selected themes.’
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Mutual Fund goes ‘Name it Hindi’ to increase the reach

According to Dale Carnegie “Names are the sweetest and most important sound in any language”.

The new financial year has started off and the mutual fund houses have a fresh resolution for this new financial year. It is to provide awareness for the schemes and broader their reach to the towns and villages, were financial literacy is a lower spectrum. With only about one-sixth of the Rs 13.5 lakh crore mutual fund industry operating beyond the top 15 cities of India. It was need of the hour for the mutual fund players to tap the untapped market.  Hence, to increase the horizon, the mutual fund players have taken new initiatives. They have broken the shackles from the age-old tradition of English names for investment schemes and are now launching mutual funds schemes with Hindi names so that people in rural hinterlands could easily connect with the schemes objectives. 

People in tows and village are not comfortable with idea of investing in stocks, bonds, mutual funds etc. There is a block in their mind that these products are suited for the white collar people only. Hence, it becomes important to connect with the audience with their own language, not yours. During recent past months, DSIJ has conducted over 50+ awareness programs to increase the financial literacy in towns and two tier cities. DSIJ is continuously involved in such process. 

SEBI is planning to limit the number of funds that mutual fund companies can operate. The idea is to reduce the complexity of the choices that investors have to make. Currently, there are over 3000 distinct funds, and several plans under most of them. Even if one looks at broad categories like equity, debt or hybrid, there are hundreds of funds in each. Therefore, the purpose of avoiding confusion among the retail investors, it targets at the level of each AMC, where each one should have just one or two funds in each category. According to reports, there will be eight debt fund categories and six for equity funds. Under the equity categories, they have simplified into large cap, mid-cap, micro-cap, ELSS, balanced funds, arbitrage funds and concentrated funds. In terms of risk against potential returns, anyone can be easily mapped to a particular need. A potential investor can easily choose which one is most suitable.