What are Thematic Mutual Funds?

What are Thematic Mutual Funds?

When it comes to investing, there are various strategies and approaches to consider. Thematic investing is one such strategy that has gained popularity in recent years. Thematic Mutual Funds are open-ended equity schemes that operate based on predetermined investment themes. In this blog, we will explore what Thematic Mutual Funds are, how they work, their benefits, who should consider investing in them, factors to consider before investing, taxation and the top-performing Thematic Mutual Funds.

How do Thematic Mutual Funds work?

To understand how Thematic Mutual Funds work, it is essential to be aware of their underlying principle. These funds invest in stocks of companies that align with a specific theme or idea. Unlike traditional Mutual Funds that may categorise investments based on market capitalisation, investment style or sector, Thematic Funds focus on a predetermined theme.

For example, if a Thematic Fund follows an Environmental, Social and Governance (ESG) theme, it will invest in companies that excel in environmental, social and corporate governance factors. These companies could belong to various sectors such as technology, financial services, fast-moving consumer goods or consumer durables.

This distinction sets Thematic Funds apart from conventional investment strategies. Thematic Funds venture across different sectors and market capitalisations as long as they adhere to the chosen theme. According to the Securities and Exchange Board of India (SEBI) guidelines, Thematic Funds must invest a minimum of <80>% of their total assets in equity and equity-related instruments related to the selected theme.

What are the benefits of investing in Thematic Funds?

1. Diversification:

Thematic Funds provide more diversification compared to Sectoral Funds. When you invest in a Sectoral Fund, your portfolio is limited to one sector, leaving it vulnerable to poor sector performance. Thematic Funds, on the other hand, diversify by investing in various sectors related to the chosen theme. For example, a manufacturing-themed fund might include stocks from industries such as construction, chemicals and engineering, reducing the risk of a single sector negatively impacting your portfolio.

2. Market-beating returns:

Thematic Funds have the potential to offer exceptional returns if the selected theme performs well. However, predicting the success of a theme is not easy and requires thorough monitoring and research. If you choose the right theme and it works, Thematic Funds can generate significant returns.

Who should invest in Thematic Funds?

Thematic Mutual Funds are suitable for specific types of investors:

1. Investors with high-risk appetite:

Thematic Funds are one of the riskiest Mutual Fund categories. Since they focus on a particular theme, the investment opportunities are restricted to companies related to that theme. If the chosen theme underperforms, there is a high risk of losses. Therefore, investors with high tolerance for risks should consider these funds.

2. Investors seeking long-term returns:

Some themes may take time to reach their full potential. For example, sectors like software and internet technology had immense potential for years before fully realising their potential. Investors looking for long-term returns can consider Thematic Funds. However, it is advisable for first-time investors to gain experience with other types of funds before investing in Thematic Funds.

3. Well-informed and evolved investors:

Thematic Funds include companies from multiple sectors related to the fund's theme. Investors who closely follow news and have a good understanding of different sectors can make informed decisions about whether a particular theme aligns with their investment goals.

Things to consider before investing in Thematic Funds

1. Investment goals:

Clarify your investment goals. Thematic Funds are best suited for investors with a long-term horizon, typically more than five years. Themes may take time to materialise, so having long-term objectives, such as early retirement or funding a child's education, aligns well with these funds.

2. Investment Risks:

Thematic Funds offer benefits but come with risks. They provide some diversification, but not as much as multi-cap funds, for example. Additionally, themes may take longer to play out than expected, leading to extended investment horizons. Understand the risks associated with thematic funds before investing.

3. Expense ratio:

Be aware of the expenses that can impact your returns. Asset management companies (AMCs) charge an expense ratio to manage Thematic Funds. This fee covers administrative and operational costs, including the fund manager's salary and marketing expenses. It is charged annually.

Taxation on Thematic Funds

Understanding the taxation of Thematic Mutual Funds is crucial for calculating post-tax returns:

1. Short-Term Capital Gain Tax (STCG):

If you sell your Thematic Fund investments within one year, any gains are classified as Short-Term Capital Gains (STCG). You must pay a 15% tax on these gains.

2. Long-Term Capital Gain Tax (LTCG):

Investments held for more than one year are classified as Long-Term Capital Gains (LTCG). Gains up to Rs 1 lakh in a financial year are tax-free. Beyond Rs 1 lakh, gains are taxed at a rate of 10%.

Top 5 performing Thematic Mutual Funds

Here are some of the top-performing Thematic Mutual Funds based on their returns in the last 3 and 5years:

• ICICI Prudential Commodities Fund Direct - Growth

3-year return: 37.82% approx

5-year return: N.A.

• ICICI Prudential India Opportunities Fund Direct - Growth

3-year return: 37.50% approx

5-year return: N.A.

• ICICI Prudential Manufacturing Fund Direct - Growth

3-year return: 31.78% approx

5-year return: 20.59% approx

• Sundaram Services Fund Direct - Growth

3-year return: 26.72% approx

5-year return: 22.08% approx

• HDFC Housing Opportunities Fund Direct - Growth

3-year return: 25.42% approx

5-year return: 15.30% approx

Thematic Mutual Funds offer a unique approach to investing, focusing on specific themes or ideas. While they provide diversification and the potential for market-beating returns, they also come with risks and require a long-term investment horizon. It is essential to understand your investment goals, risk tolerance and the theme you choose before considering Thematic Funds as a part of your investment portfolio. Always consult with a financial advisor to make well-informed investment decisions that align with your financial objectives.