Relevance Of Thematic Funds In Asset Allocation

Thematic funds must not be mixed up with core asset allocation but instead complement the existing portfolio, advise Lokesh Malhotra and VikasGaba, Founding Partners, Kainos Capital

Investing in new themes and strategies are gaining ground with investors willing to experiment with ideas that are in vogue in markets during different times. Yet, it is better for investors to keep thematic funds out of their core asset allocation strategy.

Appeal of Thematic FundsThematic funds
appeal to investors because there is a possibility of outsized returns, particularly if the theme or sector or a combination of sectors are the flavour of the season. We have seen that thematic strategies around technology and automa-tion have been doing well since the last one year as work-from-home has been increasing with the assistance of technology. However, an investor should be mindful that there is normally a higher element of risk attached to thematic funds and may not suit everyone’s risk appetite. Indeed, it is better to invest in thematic funds with the assistance of a financial advisor who is better placed to guide you as to when a sector or theme is ripe for growth.

Prevent the Wrong Mix
If one goes by the asset allocation framework, a financial planner will implement an investment strategy that strives to balance risk-reward. Investments in mutual funds are made after taking into consideration risk tolerance and one’s invest-ment horizon. Through the practice of asset allocation, one’s investment capital is spread across asset classes with an aim to balance the risk of the overall portfolio as per one’s financial goal. When it comes to building a core portfolio, it generally tends to consist of funds such as diversified equity funds, debt funds and balanced funds. An aggressive investor could also incorporate some small-cap and mid-cap funds as well.

Keep an Eye on Potential
When it comes to taking a call on having exposure to thematic funds, it is of great importance to understand the future potential the theme holds and in what timeframe could it potentially play out. Without these considerations you may be setting yourself up for negative surprises. The moot strategy behind thematic investments is to have a free hand at investing which is not chained or similar to traditional investment styles. As a result, this strategy holds the potential to provide a kicker to the overall returns’ profile of the portfolio.

But for this to happen one has to recognise market cycles and ensure you are exposed to evolving themes rather than themes that are at the end of their cycle. As things are moving fast, new themes and structures are becoming a norm. Apart from the better known healthcare, technology, infrastructure, banking and real estate themes, there are several other thematic offerings from mutual fund houses today. In certain themes, the investing universe could be small, thereby opening doors for a probable concentration risk. As a result, it may not be suitable for every investor.

Time and Timing Matters
When investing in thematic funds, entry and exit timing matters. As mentioned earlier, sometimes certain sectors are in a strong up-cycle – for example, pharmaceutical or healthcare as a theme. For several years, this theme had been underper-forming but its fortunes changed with the beginning of a global pandemic. That is why thematic funds are generally considered to be a friend of the savvy investor – those who take the right calls at the right time and have a risk appetite. Of course, returns from thematic funds can last for a few months to several years depending on how long the cycle of fortune plays out in the sector or theme.

Besides, thematic funds don’t usually have a traditional benchmark as it is generally a combination of two or more sectors. Also, while making an investment decision, do look for overlaps of sectors or themes in your core portfolio. For those considering thematic investing, do note that thematic investing is about picking on new ideas and opportunities in the markets to get a kicker in returns. At the same time, be cognizant of the risks involved. With that perspective, investing in thematic funds and especially having exposure to the right themes can complement and give a fillip to your core portfolio.

The writer is a Founding Partner, Kainos Capital
 Email: kainoscapital.in@gmail.com
 Website: www.kainoscapital.in