Betting On Thematic Funds? Timing Your Entrance And Exit Is Key

Retail investors are flocking to sectoral and thematic funds because of their rising risk appetite, according to Radhika Gupta, chief executive officer of Edelweiss AMC.

That appetite has been whetted by the high returns generated by several of these schemes in recent months, Gupta told NDTV Profit in an interview. As a result, in May, the category became the second largest among actively managed equity schemes, with assets under management of nearly Rs 3.4 lakh crore.

While investor interest is warranted, one needs to be aware that thematic funds do well in phases and are not consistent, Gupta said.

More people want exposure to small-cap and thematic funds, but the exit of these funds is harder to orchestrate than the entrance. The past performance of a theme is no guarantee for the future and the high volatility makes it difficult to time the market for a safe exit, according to Gupta.

"It is important to know when you are going to exit and also have an exit plan as you enter thematic funds," Gupta said, underscoring that high rewards and returns from thematic funds could come with high risk of loss of capital.

As an illustration, healthcare and technology related-themes did incredibly well in the immediate aftermath of the Covid-19 pandemic, but this performance fizzled eventually, and focus shifted to infrastructure and defence-related themes.

Bear markets test investors' real risk appetite. A fall in the markets tests the downside tolerance of the investor's portfolio, she said.

A business cycle fund, like the name suggests, is a thematic fund that buys stocks based early on in a cycle. Fund managers generally choose from sectors that display cyclicality like auto, metals and information technology.

Companies in these sectors tend to benefit from business upcycles, which translate into higher earnings. For example, a global ramp-up in infrastructure would raise the demand for base metals.

The fund allocation is done according to the expansion and contraction in sectors.

There are five business cycle funds that are available.

Three out of these business cycle funds have comfortably beaten benchmark returns over the last year. The other two business cycle funds from Kotak Mutual Fund and HDFC Mutual Fund have reported negative returns.

The newest offering in the space is from Edelweiss Mutual Fund. Its business cycle fund is aimed at generating returns through aggressive sector rotation.

Most financial advisers caution investors to limit their allocation to thematic and sectoral funds because of the concentration risk. They prefer diversified funds because fund managers are more capable of quickly reacting to shifting market dynamics.

Having said that, some advisors say that investors who are scouting for opportunities in thematic funds should choose broader themes that have relatively lower concentration risk.

Vijay Mantri, chief investment strategist at JRL Money, told NDTV Profit that he recommends holding up to 20% of equity investments in four broad themes — healthcare, manufacturing, consumption and banking, financial services and insurance.