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What Are Thematic Mutual Funds? Investors are increasingly betting on thematic funds these days to achieve higher returns in their mutual fund portfolios. The popularity of these funds has surged recently following impressive returns in themes like defense and capital markets. But are these funds suitable for every investor? Let’s understand the mechanics of thematic mutual funds in simple terms.

What are thematic funds?

Thematic funds are mutual funds or ETFs that invest at least 80% of their total assets in the shares of companies linked to a specific 'theme.' They invest in companies positioned to capitalize on specific long-term trends. For instance, an infrastructure fund would invest in shares across various sectors involved in infrastructure development nationwide. These funds can be either actively or passively managed.

Some popular themes in the country include defense, capital markets, consumption, tourism, energy, digital, PSUs, and manufacturing.

Why do thematic funds carry higher risk?

Unlike large-cap, flexi-cap, or multi-cap funds, thematic funds are not fully diversified. They invest in a select group of stocks, resulting in higher concentration risk.

However, thematic funds offer slightly more diversification than pure sectoral funds (such as those focused solely on IT or Pharma), meaning their risk profile is somewhat lower than that of sectoral funds.

If you invest when economic conditions favor the specific theme, these funds can deliver excellent returns.

Who should invest in them?

According to financial planners, the timing of entry and exit is crucial for generating high returns from thematic funds. Only investors who have a solid understanding of market entry and exit timing should invest in these funds. New investors should avoid thematic funds and start with diversified equity mutual funds.

Experts suggest that once your core portfolio is established, you can—with an understanding of the associated risks—include one or two thematic funds as part of your 'satellite portfolio.'

What is the right way to invest in thematic funds?

Unlike diversified funds, the simple 'buy and hold' (or 'buy and forget') strategy does not work for these funds. A calculated approach is required:

Staggered approach (SIP/STP): If you anticipate that a specific event will benefit a particular theme over the coming year, you can invest gradually in installments.

Lump-sum investment: If you believe the theme could perform well at any time, you may opt for a one-time investment.

Buying the dips: Investors can make small lump-sum investments or increase their investment in installments during market corrections over a period of 3 to 6 months.

Overall, thematic funds can be an excellent way to boost your portfolio's returns, but they also carry significant risk. Therefore, allocate only a limited portion of your portfolio to these funds and be prepared to exit in a timely manner if the theme deviates from its expected trajectory.

Disclaimer: This content has been sourced and edited from Money Control. While we have made modifications for clarity and presentation, the original content belongs to its respective authors and website. We do not claim ownership of the content.