Here's why you should invest in theme funds

In CNBC-TV18’s personal finance segment, Hemant Rustagi, Wiseinvest Advisors advices investors to be cautious while investing in a sector fund. He recommends investment in thematic funds as they are broad, more diversified compared to a sector fund.

Below is an edited transcript of Hemant Rustagi’s interview on CNBC-TV18 Q: How much relevance do sector or thematic funds hold at all for retail investors in any market conditions including the current market conditions? Would it make more sense to give complete freedom to the fund manager and therefore prefer balanced funds or just an equity fund like the Top 200, an HDFC Prudence where the fund manager has complete equity freedom or in a balanced fund where he has equity to debt freedom? Or should you prefer thematic funds where sometimes you can get dramatic gains like someone investing in real estate fund a year ago would be sitting in a gold mine?
A: I agree. One of the best things about investing in mutual fund is that mutual funds offer a variety of funds in each asset class. If you look at equity as an asset class, there are a lot of funds that are available.
There are diversified funds, funds that focus on each segment of the market - large cap, midcap and small cap and there are thematic and sector funds. Every investor who wants to take exposure or invest in mutual funds has a lot of options to invest in, but if you discuss these two funds, the sector fund can be described as intermediate between investing in stocks of a sector and a diversified fund.
If you look at a thematic fund, it invests in fund that fit into its theme but could be across multiple sectors. A sector fund is good for an experienced investor who understands the sector, both in terms of what the potential is, what the risks are and seeks diversification in that sector. So in a way a sector fund can then support to a diversified portfolio by allowing investor to increase exposure to those sectors that have under-representation in a particular portfolio. But for a sector fund the investment universe is quite narrow, so they can be quite risky and volatile.
Investors need to be very careful while investing in them, but in terms of whether they should be investing in them at all, whether they have the risk profile to actually invest in these and also if they invest, how much should they be investing and also the selection of sector is very, very important.
On the other hand if you look at thematic funds they are broad, more diversified as compared to a sector fund. What they are looking for is the trend which can result in outperformance of some sectors or certain stock. But the problem on the flipside is that the theme, if it does not materialize or the market takes more time to realise the potential of the theme which becomes the basis of launching a thematic fund, there can be prolonged period of underperformance. So both these categories have the potential to do well, but can be quite risky, so investors need to be careful before investing in them. Also Read: Banking, FMCG funds top MF return charts in 2012

Also, I believe that even if an experienced investor wants to invest in these funds he should not be investing more than 10-15 percent of the portfolio. As far as retail investors are concerned, it is quite evident that these funds are not ideally suited to them. They also need to realise that all these diversified funds which have a consistent performance track record invariably would be investing in sectors and themes that have potential to do well.
That is why they are able to perform well over a period of time, but we have seen time and again retail investors jumping into these funds especially when the markets are doing well. They need to be very careful and should not be investing very aggressively in these funds if at all. A well diversified portfolio takes care of needs of retail investors, because if the objective is to build a corpus over a period of time the focus should be on diversified fund and not so much in aggressive funds. Q: Like we measure the performance of an equity mutual fund against its peers or benchmark index, what is the measure of performance of a thematic fund? What allocation should be made to a fund like this or should it be avoided altogether?
A: Thematic funds are more diversified, but if you compare them with diversified fund, they are more aggressive because these funds look for a trend that can result in outperformance. It is clearly an issue of an investor knowing what his risk profile is, some percentage of the portfolio can be invested in that. But if you look at the benchmarking of these, for example, sector funds you have a benchmark, you can see whether the fund has done well or not.
If you look at thematic funds even though like diversified funds and sector funds, they also have a benchmark but considering that there are varieties of thematic funds which are available in the market, some of them are broad based like you have these infrastructure funds and then there are some funds which have very narrow investment universe. It depends on the risk profile of an investor and only an experienced investor should invest in them. So once you become an experienced investor, at least you have some idea. Q: What investor is asking is whether those benchmarks are good? For instance, you put in an infrastructure fund, I do not know if there is an infrastructure index at all. There is a BSE PSU Index, a BSE Capital Goods Index, it may not be exactly an infrastructure index. So when these sector funds are announced do they give their benchmarks as well?
A: Of course most of the sector funds have their own index, but if you look at thematic funds most of these infrastructure funds are having Nifty 50, Sensex or BSE 100 as a benchmark and the reason for that is that these are quite broad based and are very different from infrastructure stocks that we discuss. Because the theme over there is to invest in the companies that can be instrumental in improving the infrastructure in the country and also that can benefit from the infrastructure growth in the country.
It is a board based index. Most of the other thematic funds that you see there are relevant benchmarks but only problem is they are unique in nature, you cannot compare them with peer groups because there may not be too many examples there, whereas in case of infrastructure funds you can look at a comparison with a peer group but not in every thematic fund.