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Should you Invest in Theme based mutual funds?

Thematic Mutual funds generally allows better returns instead of general mutual funds.

As you would have known from our recent blog "Equity mutual funds are a better option than investing directly in stocks. It allow investor earn more returns with lesser effort".

But did you know? that, you can take a step ahead in mutual funds by investing in a very specialized theme-based funds.

Let's have a look at what it's all about and how it can help in making more returns.

(A) What are Sectorial (Theme-based) Mutual Funds?

Thematic funds are also equity mutual funds that invest in stocks tied to a theme.

Generally, These funds are different from diversified Mutual funds. Because as the Fund Managers pick specific companies and sectors that has tailwind for multiple factors for a period of time. For instance, an infrastructure theme fund will invest in companies like cement, power, steel among others.

Note : one should always remember that, thematic funds are purely played on the basis of special economics tailwinds, so exiting during the right time before tailwinds ends is important.

(B) Where do Thematic Mutual Funds invest?

Theme Based funds or Thematic Funds have to invest 80% of their assets in stocks tied to a particular theme. For instance, a Thematic Fund will invest in stocks related to the theme of Infrastructure, Industrial capex, Green Energy and so on.

This means they invest in companies connected to the development of infrastructure, Green Energy, Industrial Capital goods of our country like those operating in Machines, Solar or renewables, etc.

(C) Who should invest in Sectorial (Theme based) Funds?

An Investor who is likely to take higher rewards against higher risk of both market volatility and macro development.

However, If theme doesn't work, then none of the associated stocks will perform, resulting in massive underperformance.

In addition, Investor should invest only 10% of the portfolio into these funds.

(D) Parameters to Analyze before investing in Sectorial (Theme based) Funds


Click on the image to see enlarged view

Sectorial (Theme Based) Mutual Funds - Overview

(i) Fund Performance vs Benchmark Performance

Sectorial (Theme Based) Mutual Funds - returns Comparison

Now as you have already known, This is one of the first things most investors check for in a scheme.

However, what percentage return indicates a good performance? How do you know whether your selected fund has performed well or not?

The performance of a particular fund must always be compared with the performance of the respective benchmark for the fund. Each scheme necessarily has a benchmark, which it aims to outperform. Since you are investing your hard-earned money, you will expect your fund to beat its benchmark and create higher Alpha. 

Hence the first parameter while analyzing a mutual fund is to select funds that have consistently outperformed its benchmark.

(ii) Total Expense Ratio

Sectorial (Theme Based) Mutual Funds - Expense Ratio Comparison

The expense ratio is the percentage of total assets that a mutual fund charges an investor annually for managing their money.

The expenses related to Mutual Funds fall into 5 categories-

  • Distribution charges;
  • Security transaction fees;
  • Management fee;
  • Investors transaction fee;
  • Fund service charges.

Basically, the expense ratio reduces the returns available to the investor. Therefore, an investor should look for funds with a lower expense ratio.

(iii) Strength of the fund

Sectorial (Theme Based) Mutual Funds - Strength Comparison

Strength of a fund is analyzed by an indicator called Strength Indicator. It is an indicator which tells that how resilient a scheme is in market volatility and its ability to generate a higher return at lower risk using ratios such as standard deviation, Sharpe ratio, etc.

  • Standard deviation – refers to the volatility of a fund. Higher the standard deviation, the more volatile the returns will be. This means you should choose the funds with the least St. dev.
  • Sharpe ratio – refers to the additional returns generated by the fund per unit of risk taken. A higher Sharpe ratio means better risk-adjusted returns for the investor. So, it is advisable to choose fund whose Sharpe ratio should be at least higher than its benchmark.

In the above image, you can check we have identified 3 higher Sharpe ratio, and 2 Lower Standard deviation. So based on that we can take a decision that which Fund is good as per the parameters.

(iv) Study the fund’s Beta

Sectorial (Theme Based) Mutual Funds - Beta Comparison

The Beta measures the risk involved in a fund.

  • Beta > 1 = the fund gains or loses more than the benchmark.
  • Beta < 1 = the fund gains or loses less than the benchmark.

Here again, if you look into the above image you will find 2 of funds having the least beta, So based on that we can take a decision that which Fund is good as per the parameter.

(v) Rolling Returns Analysis

Sectorial (Theme Based) Mutual Funds - 260 Days Rolling Returns Comparison

You must have heard the line ‘past performance is not an indicator of the future performance’, while this is true, there is no better alternative to this. By studying the past returns and its behavior, we would at least know what to expect.

Let’s analyze it with an example, we can see in last 4 years Nifty 500 has an average rolling returns (260 days) of 18% while Sundaram Services fund India has an average returns of 25%.

We can also check the highest and lowest returns of the fund against the benchmark in the above table. Meanwhile, the +ve% is the percentage of all the rolling returns that are positive.

vi) Fund Manager

Apart from the above-mentioned points, there are some other aspects which can also be look upon.

The performance and history of the fund manager are crucial. An investor can look at the experience that the fund manager has, other schemes that the fund manager is managing and so on.

This increases the reliability and confidence that your hard-earned money is in safe hands.

Moreover, the reputation and history of the fund house, under which the scheme belongs can also be looked upon.

(D) Conclusion

Knowing what to look at while evaluating a mutual fund, leads to the selection of a good mutual fund. This knowledge can go a long way in helping you make the correct investment.

It must always be kept in mind that investment in mutual funds is subject to market risks. Therefore, doing proper due diligence is beneficial.

If you still find difficulty in selecting a mutual fund you can consult a financial advisor, who can guide you based on your risk profile.

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References: Updates from Mutual Fund Companies.

Disclaimer: The report only represents the personal opinions and views of the author. No part of the report should be consider a recommendation for buying/selling any stock. Thus the report & references mentioned are only for the information of the readers about the industry state.

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