Thematic Funds: Meaning, How They Work & How To Invest (2024)

All mutual funds have an underlying asset that fetches return for them. In the case of large-cap funds, the underlying assets are the stocks of some of India’s biggest companies in terms of market capitalization. Similarly, thematic funds have stocks of companies as underlying assets that are united by a predetermined theme.

For instance, if a fund follows an ESG theme, it will invest in companies that have fared well in terms of environmental, social, and (corporate) governance factors from different sectors (from technology to financial services to FMCG to Consumer Durables).

This is what setsthematic fundsapart from the conventional approaches of investing, such as investment based on – market capitalization (large-cap, mid-cap, small-cap), style (value & growth), or sectoral (pharma, technology, infrastructure). It invests across different sectors and market caps as long as it ties to the theme. Also, according to SEBI, the minimum investment in equity and equity-related instruments of a particular theme shall be 80% of total assets.

• Offers More Diversification than Sectoral Funds:

  When you invest in a sector fund, no diversification opportunities are provided as your portfolio is restricted within the confines of one sector. Your portfolio will be negatively impacted if, for some reason, the sector is not performing well. On the contrary, in thematic funds, you get some amount of diversification as it invests in line with a theme that may have stocks of companies that belong to various sectors. For instance, let’s take a fund that has manufacturing as its theme – It invests in a host of companies that belong to different industries, from construction to chemical to engineering to others. So, even if companies from one sector don’t perform well at a given point in time, other sectors will protect your portfolio from failing miserably.

• Market-beating Returns if You Get the Theme Right:

  Thematic funds can fetch outstanding returns for the investor if the theme they opt to invest in hits the spot. Having said that, we also need to understand that getting the theme right is not that easy as it sounds. It requires a lot of monitoring of the theme that you are interested in, requires following up on news and headlines regularly. After all your arduous efforts, if you manage to get the theme right – then thematic funds are capable of generating good returns for you.

  See Also

  What are thematic funds? Should you invest or not?CFA Exam PrepWhat Is Thematic Investing? | The Motley Fool

• Investors with High-Risk Appetite:

  Thematic funds are one of the riskiest mutual fund categories. That’s because when a portfolio is built with a theme in mind, the scope of investment opportunities get restricted. It would have to invest only in those stocks that are related to that theme. So you have a semi diversified portfolio. And if for some reason that theme doesn’t play out, the risk of losses is pretty high. So investors who can stomach high risks should invest in these funds.

• Investors Seeking Returns in the Long Term:

  Sometimes, for a theme to operate at its full potential it takes time. For instance, we always knew that software and internet technology had immense potential since the early 90s. But only now, after 20 years, we can see these themes operating at their full potential. Thus it takes time and patience for these themes to materialize into great investments. So, if you are an investor who is looking for good returns in the long term, thematic funds can be a good option for you. However, it’s recommended that first-time investors shouldn’t directly jump into thematic funds at the start of their investment journey.

• Well-Informed and Evolved Investors:

  The portfolio of a thematic fund consists of companies’ stocks from multiple sectors related to the fund’s theme. Not every investor would have an idea about the development of all these sectors. When you have a fair understanding of different sectors in line with the theme of the fund, you can make a better call as to whether the areas can help you get good returns. So, investors who follow the news regularly and have a knack for delving into a variety of sectors can invest in thematic funds. Tracking different areas helps investors gather valuable insights that can help them decide whether to invest in the theme.

• Investment Goals:Before investing in these funds, one should be clear about their investment goals. If you want to make the most out of your investment in thematic funds, then you should have an investment horizon of more than 5 years. The reason is simple. For any sector to reach its peak, it takes a significant amount of time. Thus, you should have long-term goals like early retirement, funding a child’s education, etc. while investing in these funds.
• Investment Risks:Although the benefits of investing in thematic funds might seem attractive, it is essential also to understand the risk associated with thematic funds. It is a high-risk avenue. That’s why first-time investors are recommended to stay away from investing in thematic funds. Let’s see what the key risks associated with these funds are:
  • Semi-Diversified Portfolio:The portfolio of a thematic fund is slightly more diversified than that of sectoral funds, which offers no diversification. However, it offers lesser diversification options than other equity funds likemulti-cap fundswhose portfolio comprises stocks from varied sectors. As these equity funds are not tied to the theme; thus, the probability of all the stocks going down at once is lesser in them as compared to thematic funds.
  • Some Themes might take Longer to Play Out than Expected:Even though some of us may see a strong potential in a theme in the near future -say 4 to 5 years – there’s a high risk of our predictions going wrong. It might take longer than we calculated it to be. For instance, the year 2007 was golden for infrastructure. Many new thematic funds were launched and a lot of investors wanted to capitalize on it. It’s been more than 10 years and yet the infrastructure theme hasn’t witnessed any real development. An investor might have to wait up to 20 years to make good returns from their investment in thematic funds. Thus, there’s a risk of time with thematic funds.
• Expense Ratio: You should be cut-clear about the expenses that bite into your returns. In order to manage the thematic funds you’re planning to invest in, asset management companies (AMC) charge you a fee called an expense ratio. This is basically the charge to cover the fund’s administrative and operating expenses like the fund manager’s salary, marketing costs, etc.. It is charged on an annual basis.

It’s the post-tax returns that matter. In order to determine that, you should be familiar with how thematic funds are taxed. The capital gains made as a result of selling your thematic fund are taxed depending on how long the investment was held by you.

• Short-Term Capital Gain Tax (STCG): If you sell your investments within 1 year, the gains are classified as Short-Term Capital Gain (STCG), and you need to pay a 15% tax on them.
• Long-Term Capital Gain Tax (LTCG):Whereas any thematic investment held for more than one year, the gains are classified as taxed Term Capital Gain (LTCG). Gains of up to 1 lakh in a financial year are tax-free. Beyond 1 lakh, the gains are taxed at a rate of 10%.

It is quite easy to invest in Thematic Funds on ET Money. All you need to do is just follow the below-mentioned steps:

• Download ET Money app or visit:etmoney.com/mutual-funds/equity/thematic/44
• Find the Thematic Fund you want to invest in.
• Click on Invest Now, and enter the amount and mode of investment.
• Provide basic details like Pan & Bank Details & you are all set.