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Thematic Funds: A Beginner’s Guide

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Thematic Funds in India

By: Tavaga Research

Thematic funds are predominantly a type of equity mutual funds that invest in companies tied around a well-defined theme across various sectors. For instance, a fund built on farming/agriculture theme might invest in equity stocks belonging to the automobiles, chemicals, fertilizers, core agriculture stocks.

Thematic Funds India: How is the market for Thematic Funds in India?

Currently, there are around 80 thematic funds in India which are mostly actively managed, with a combined AUM of around Rs. 54,000 Crores, a commendable corpus growth from the Rs. 37,000 Cores AUM 3 years ago.

SEBI regulations mandate at least 80% investment of thematic funds in equity securities of companies that revolve around the theme. Though not strictly stipulated, thematic funds in India invest in sectors following themes like rural consumption, rural India, international trade, global exposure.

  • Growth opportunities for a particular theme in light of the macro-economic as well as socio-political scenario need to be carefully assessed before venturing into thematic investments
  • The moderate risk involved in thematic funds can be managed if invested over a long horizon of around 5 years

Recently, Edelweiss AMC launched India’s first Thematic Index Fund, Edelweiss MSCI India Domestic & World Healthcare 45 Index Fund, in association with MSCI (Morgan Stanley Capital International). The fund intends to provide returns closely corresponding to the MSCI India Domestic & World Healthcare 45 Index.

Top Performing Thematic funds in India

  1. Aditya Birla Sun Life MNC Fund

It is an actively managed open-ended equity fund scheme that follows the MNC theme. The fund aims to maximize return on capital at a minimal risk level by investing stocks of multinational companies through an actively managed investment strategy.

Investors looking to stay invested for more than 3 years would benefit the most out of this through long term capital growth. 80% of the fund comprises of equity investments of MNCs while the other 20% is mostly non-MNC equities or money market instruments.

2. SBI Magnum Equity ESG Fund

This is an actively managed fund that follows the theme of Environmental, Social, and Governance (ESG). It tries to capitalize on the ever-growing concern towards eco-friendly products, low –emission vehicles, and socially amicable consumer behavior.

Companies are scored across the parameters which affect the environmental, social and governance aspects of a company. Around 80% of assets invested are ESG focused equities whereas the other 20% is a combination of either debt/money market instruments or non-ESG equities.

3. SBI Magnum COMMA Fund

This fund predominantly invests in companies engaged in the commodity and commodity-related businesses.

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Thematic Investments in the US:

Thematic Exchange-traded Funds (ETFs) have seen remarkable growth in the last few months with these ETFs growing as much as 3 times the industry for Exchange Traded Funds. Thematic ETFs, which by the name of it, invest in the long term and disruptive trends in the economy, has beaten the S&P index on a year to date basis.

On a global level, the corpus under thematic ETFs has grown from $5 Billion in assets in 2015 to $41 Billion in assets today.

The Covid-19 pandemic has certainly disrupted the economy as well as the social construct of human lives. There is going to be a paradigm shift in the way companies go about their business and how consumers behave. The prospects of a different looking future have been amplified more than ever; and thematic ETFs focusing on long term disruptive trends such as Lithium battery technology, cybersecurity, Fintech has scored big returns; as is evident from the below graph for the 1-month return for Thematic ETFs in July 2020. The thematic ETFs’ performance is benchmarked against the MSCI Index to demonstrate the outperformance.

Thematic ETF Returns
Source: Bloomberg, Global X ETF, Tavaga research

In US, thematic ETFs have been colloquially and very loosely used to define funds which largely focus on companies leveraging up and coming up with environmental and social trends as well as disruptive trends such as robotics, cloud computing etc. The strict definition for thematic investing though is stipulated as identifying the structural trends that disrupt the global economies and identify companies that stand to materialize from those trends.

Though thematic ETFs can be misconstrued as largely focused on high-tech and disruptive companies, they also focus on tapping themes such as shifting consumer behavior, government policy changes.

Thematic ETFs are constructed by fund houses in conjunction with index providers to create customized indices to get targeted exposure to companies that are most likely to benefit from the trend that underlies the theme of the ETF.

Some of the most popular themes and thematic strategies revolve around:

  • Internet of Things (IoT)
  • Robotics
  • Electric Vehicles
  • Renewable Energy

How are thematic funds different from sectoral funds?

Where Sectoral funds are completely invested in equity instruments of its specified sector; thematic funds can actually take exposure to a wide array of sectors that are centered around a specific theme. For example, a thematic fund looking to capture the growing trend of Affordable Housing can consider investing in Cement, Paints, Housing Finance companies.

What are the advantages of investing in thematic funds?

  • The scheme of diversification in such funds is more intricate, as rather than focusing on merely geographies or sectors, its aimed at a broader theme or trend

For example, taking healthcare as an example in the current pandemic scenario, there’s wide-scale adoption of the latest and cutting-edge technologies in healthcare as well as increasing demand for enhancing the medical infrastructure in hospitals and institutions.

So, a thematic fund would concentrate more on investing in the specific companies which stand to benefit from this boom- these companies can be healthcare, pharmaceuticals, medical instrument manufacturers, etc.

  • Thematic funds are better for medium to long term investments
  • If any of the constituent companies in a thematic fund charts a sustaining winning spree, the thematic fund directly benefits from it

Thematic Investing: Should you go Passive or Active?

While developed counterparts such as the USA have a well-endowed market for thematic passive funds, the Indian ETF segment is slowly but steadily catching on steam with around 100+ ETFs and Index funds (AUM of 2 lakh crores) racing on the bourses wrapped around an AUM worth Rs. 27.5 lakh Crores.

  • Given the underperformance of Active funds, both from a long term and medium-term perspective, passive investments have gained the upper hand when it comes to mode of investing
  • Greater alpha-generating capacities of passive funds given the low costs involved certainly make index funds and ETFs a favorable investment vehicle
  • Thematic funds looking for laser-focused exposure to certain sectors to satisfy its objectives are better suited when picking from index funds of sectors like healthcare, technology, consumption, which when exploited judiciously, offer juicy rewards in the long term
  • Thematic funds, which are most popular for global exposure to companies engaged in disruptive technologies, are catered to by the numerous index funds through the pre-determined criteria of the index basis. Most Active Mutual Funds in India don’t have the expertise and physical resources for equity research on a global scale

Given the risks involved, how much share of one’s portfolio be invested in thematic funds?

Market volatility is a common factor in all thematic funds, given the nature of the constituent securities involved; and one must thoroughly research the theme of investment. Thematic investments should constitute roughly 5- 10 % of one’s investment portfolio.

How to Invest in Thematic Funds?

There are broadly two ways to go about investing in thematic funds:

  • Offline: One can invest through the broking account or contact the closest branch of the asset management company of the fund
  • More efficiently, one can go on online platforms who offer a wide array of thematic index funds as well as ETFs to meet one’s investment goals

How to pick a winning theme for investment?

Well, this isn’t a straightforward question to begin with; and a long-term persistent trend should almost always underlie the investment rationale behind it. At its core, thematic investment is about scouting for candidates who stand to capitalize on a given theme or trend in the economy.

For example, if years ago, one would have invested their money in the online shopping theme; not only e-commerce companies but also logistics companies and delivery services would have fallen under the ambit of a thematic investment fund trying to capitalize on the shifting consumer behavior with respect to shopping.

Another approach to thematic investment might be in identifying future visionaries who plan on building a scalable solution to a current problem. For example, hybrid and electric vehicles might well be the road –runners of tomorrow, and a company like TESLA sure looks like a winning investment to ride the wave to come.

Most importantly, one needs to configure the cost of positioning one’s investment corpus in a handful or even a bounty of companies, sectors or countries that are believed to outperform the broader market on a longer-term basis but also undergo intermittent troughs as well.

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