Thematic Funds: Benefits, Types And Risks Involved

Various fund houses and mutual funds take into consideration a variety of concepts and strategies to build their portfolio. The concept of following a theme gave birth to a category of mutual funds called “thematic funds”. These are a type of open-ended equity-oriented funds that invest 80% of their corpus in stocks of multiple sectors based on a predetermined theme. 

So, let’s say that an asset management company follows a theme of healthcare. The thematic fund manager will invest in stocks of pharmaceutical, biotechnology, or equipment selling companies. 

If you are interested in exposing your funds to a particular theme, keep reading further to learn more about thematic funds.  

Difference between Thematic and Sectoral Funds

Often, investors get confused between sectoral and thematic mutual funds. However, to make an informed decision, investors must know the difference between the two.

• Investment area 

Sectoral funds only invest in a specific sector. For example, a fund manager will only invest in stocks in the banking sector. However, thematic investing focuses on following a particular theme and spreads across multiple sectors. 

• Diversification of assets

With the ability to invest in the stocks of multiple sectors, a thematic fund manager can build a diversified portfolio. In the case of sectoral investing, one is restricted to a particular sector, reducing the opportunity to diversify. 

• Risk involved 

As sectoral funds offer less diversification and focus on one sector, they are riskier investments. However, following the common saying “higher risk, high returns,” sectoral funds have better growth return potential. Nonetheless, as both invest in equity-oriented instruments, the risk involved is always on the higher side.

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Common Types of Thematic Funds

There are a few themes that gain more traction and are among the popular types of thematic mutual funds. Some of these themes are as follows:

• PSU fund: In Fund house invests in shares of businesses run by the government. 
• Manufacturing theme fund: The portfolio includes stocks of companies that deal with the creation or production of goods.
• MNC fund: AMC invests in shares of multinational corporations that are listed on the stock exchange. 
• Energy fund: Fund managers invest in stocks of companies engaged in the energy and natural resources business. 
• ESG theme fund: The portfolio includes shares of companies that are evaluated based on environmental, social and governance factors. 
• Consumption fund: These funds invest in consumption-oriented sectors, like automobile, durables, telecommunication, consumer goods, etc. 

Benefits of Thematic Investing

Investors of thematic funds will be able to enjoy the following two major benefits:

• Diversification 

So far, it is clear that thematic funds offer more diversification than sectoral funds. But one might wonder how this feature is relevant and beneficial. Well, less diversification means that your portfolio is more sensitive to the fluctuations that occur in one sector. Thus, if the sector does not perform well, your returns might decline drastically.

However, thematic funds reduce this sensitivity by investing across different sectors. As equity instruments are themselves quite volatile, these funds try to spread this volatility across industries. Let’s consider this: if the stock price of one MNC is on a downtrend, but those of another is soaring, your losses will get balanced out.

• Appealing returns

Even though most investors do not follow an investment strategy and try to go with the flow, if they pick the right theme and enter at the right time, they can earn returns way above the benchmark. 

Indeed, it is not easy to spot the right theme and fetch outstanding returns. It requires constant monitoring and analysing of sectors and their positioning in the respective market. Fortunately, you have fund managers and advisors who can assist you in finding a profitable theme.

Also Read: All You Need To Know About Different Types Of Mutual Fund Risks

Risks Involved with Thematic Funds

Inherently, equity funds are riskier than other types of mutual funds. However, investing in thematic funds comes with certain other risks involved. As compared to other mid-cap and large-cap funds, thematic investing can involve higher risks. This is because the target industries might perform tremendously one year but tumble the next. 

So, if you enter a thematic fund based on how it performed last year, you might end up with losses. Furthermore, to allow this scheme to balance the losses that it suffers from during economic downturns, you will have to remain invested for a longer duration. 

Taxation on Thematic Funds

Taxation on a thematic fund works the same way as any other equity mutual fund. So, if you redeem your investment within 12 months from the date of purchase, your returns fall in the category of short-term capital gains. Thus, you pay a tax of 15% (plus surcharge and cess) irrespective of your income tax slab. 

However, if you stay invested in the fund for 12 months or longer, the tax you will pay on your return will decrease to 10%. Furthermore, according to the Income Tax Act, investors also enjoy a tax exemption of Rs. 1 lakh on their long-term capital gains during a financial year.

Who Should Invest in Thematic Mutual Funds? 

It is clear now that thematic funds can be profitable when investors can pick a suitable theme. Thus, in order to invest sensibly, one should have in-depth knowledge about the market and macroeconomic conditions. These funds are not ideal for amateur investors, who cannot keep up with fluctuations and business cycles of various sectors. 

Also, given that it takes a longer time for thematic funds to offer returns, it suits the needs of investors seeking long-term results. Lastly, as they are a part of equity mutual funds, thematic investing is suitable for those with a high-risk appetite. 

Final Word

The investment market is becoming massive, as multiple industries are rising and becoming profitable. But if you are someone who intends to generate hefty returns by investing in attractive sectors that are united by a theme, thematic funds are the one for you. These open-ended schemes can also help you diversify your portfolio.

However, you have to be careful about the risks and limitations of investing in thematic funds. Given its high-risk and advanced nature, this fund might not suit the portfolio of every investor. 

Frequently Asked Questions

1. How long should I stay invested in thematic funds?

Thematic funds are generally ideal for long term investments. Due to their high risk and volatile nature, an investor needs to be patient with these funds. To offset any short term losses that sectors might undergo, individuals might want to consider an investment time horizon of 5-7 years. 

2. How does the expense ratio impact my overall returns?

Expense ratio is an annual fee that an asset management company charges to maintain and manage the fund. According to SEBI guidelines, a fund house can charge a maximum expense ratio of 2.25%. As this charge applies to your funds’ assets, it reduces the overall returns you earn. 

3. Are there any tax benefits on short term capital gains of equity funds?

Sections 80C to 80U of the Income Tax Act offer tax deduction and exemption on short term capital gains. However, as the returns of equity-oriented funds fall under section 111A, these benefits do not apply to thematic funds. 

4. When should I enter and exit a thematic fund?

In the long haul, it does not matter when you enter a thematic fund as the profits tend to compensate for the losses. Investors should stay invested for as long as they can to benefit from the power of compounding. 

5. Can I redeem my thematic fund investment at any time?

Yes, you can redeem your principal amount along with the returns on any business day. Thematic funds are open-ended and have no lock-in period. Thus, they offer you the liquidity to convert your investment into cash in case of any emergency.

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Disclaimer- Mutual Fund investments are subject to market risks, read all scheme-related documents carefully.