Why you should steer clear of new thematic funds

Many mutual funds (MFs) were on a money-raising spree in 2020. And they did so by rolling out new schemes. According to ACE MF, 50 equity new fund offers (NFOs) were launched. With the S&P BSE Sensex rising 84 percent between March and December of 2020, fund houses have been keen to capitalize on the rally. And what better way to attract investors than a new and exciting theme we hadn’t heard of before?

Small wonder then that of all these NFOs, 11 were thematic funds. Seven fund of funds were also rolled out, two of them are international schemes. And to keep costs low, 16 index funds and ETFs were launched as well.

The Securities and Exchange Board of India’s (SEBI) 2018 rule allows just one scheme in each category. So, fund houses have now taken to rolling out multiple ETFs and thematic funds. Will investors benefit or have fund houses gone back to gathering assets at any cost?

Investing in new areas

Some fund houses are focusing on offering new strategies to invest in sectors and companies through their thematic schemes. As markets mature, ETFs are being offered in themes that were earlier difficult or tricky to be mapped passively.

For instance, while most mutual funds have launched actively managed schemes around ESG, Mirae Asset ESG Sector Leaders Fund decided to choose the passive investing path. Edelweiss MSCI India Domestic & World Healthcare 45 Index Fund invests in both domestic and global healthcare stocks. Nippon India Passive Flexicap Fund decided to offer a multi-cap portfolio using passive products based on market wisdom.

“Many NFOs unveiled in the last one year are designed by keeping in mind investors’ future needs,” says Swarup Mohanty, CEO, Mirae Asset Investment Managers (India). “Innovative products are being rolled out on the ETF side and fund houses are working on investment solutions catering to specific needs of investors using passively managed equity funds,” he adds.

Since millennials find it convenient to transact through stock exchanges, fund houses see ETFs as an opportunity to bring in first-time and cost-conscious investors through ETFs. “Many investors cannot decide whether to invest in large, mid or small-cap funds. If the fund manager does this through fund of funds, then investors might find that convenient,” says Joydeep Sen, corporate trainer (debt markets). “Fund of funds allocating money to low-cost exchange traded funds makes sense, given the overall low costs compared to actively managed funds,” he adds.

Problem of plenty

As more fund houses join the NFO bandwagon in the name of differentiation, it could lead to a crowd of schemes. Sifting through them might be challenging for the lay investor. “Too many mutual fund schemes will add to investors’ confusion,” says G Pradeepkumar, CEO, Union Mutual Fund.

Consider the banking sector. If you wish to avoid fund manager’s risk and invest in a passive fund, do you choose, say, Nippon India ETF Bank BeES Or Kotak PSU Bank ETF? Or, should you choose private-sector banks and pick, say, the ICICI Prudential Private Banks ETF. And, there is a large list of actively managed banking and financial services funds, too.

Besides, in thematic and sector funds, you have to get both the entry and exit right. Many a time, themes are marketed using their recent performance.

“Sector funds should only be launched with a clearly defined built-in mechanism for booking profits,” says Pradeepkumar. “Though many times investors are told when to enter a sector, rarely do fund houses advise investors to actually get out of that fund. This sours investors’ experience in sector funds and narrowly-defined theme funds,” he adds.

Why thematic funds should not be your first choice

It’s easy to get swayed by themes based on their recent performance. The reality is that “Many themes are sub-sets of the stock universe of diversified equity funds. Average investors are better off with diversified equity funds,” says Nitin Shanbhag, head-investment products, Motilal Oswal Private Wealth Management. For example, the star performer of CY2020 – the healthcare segment – is present in almost all diversified portfolios. Investments of diversified equity funds in healthcare and software stocks have gone up considerably over the last one year.

Also, applying the ESG criteria may be a preferred way to invest. Many fund houses are incorporating the ESG way investing in companies. “If sustainable investing is a way of ensuring higher-than-market returns, then don’t you think a fund manager will be applying the ESG norms to a diversified equity fund which may not talk about ESG investing,” asks a fund manager requesting anonymity.

Avoid thematic funds for your first, second or even your third investment vehicle. Consider them only if your portfolio needs any further diversification. If you do not find an existing alternative, you may consider a thematic fund.