What are Thematic Funds? How do they work?

Say you care deeply about the environment, and investing in a company that disregards eco-conscious practices simply doesn't align with your values. So, now you're seeking a solution that not only aligns with your moral values but also offers an opportunity to earn potential returns.

Enter the world of sustainable investing, where a special kind of fund ensures that only companies adhering to specific environmental norms are included in your investment portfolio. These funds invest in carefully selected businesses that prioritise sustainability, conservation, and a greener future. Introducing ESG Funds where E stands for Environment, S for Social and G for Governance.

The Environmental section sets the stage for companies that prioritise clean energy, waste reduction, and ecological conservation. The Social segment shines a spotlight on businesses that prioritize fair labour practices, human rights, and community development. And the Governance element ensures a strong melody of transparent leadership, ethical decision-making, and board diversity.

Here, ESG Funds revolve around a specific theme, which centers on companies that hold the environment, social responsibility, and ethical governance in high regard. To put it simply, these funds are designed to invest selectively in businesses that place a significant emphasis on these crucial aspects.

So What Are Thematic Mutual Funds?

Thematic funds are a type of Mutual Fund schemes that are focused on specific themes or trends, such as clean energy or technology. These funds invest in companies that are related to the specific theme, in order to capitalise on growth opportunities and generate returns for investors. The five broad themes for which mutual fund schemes exist are dividend yield, PSU, MNC, Energy and consumption. Several smaller themes, such as manufacturing, quant, commodities, exports, services, and transportation, have one or two funds.

Thematic Funds are actively managed and aim to offer investors like you an opportunity to gain exposure to a targeted theme with the potential for high-growth opportunities and alignment with their values or beliefs and high risk. However, you should carefully evaluate the risks and potential rewards of investing in a Thematic Fund. You should consult your financial adviser if you are in any doubt as to whether this product is suitable for you.

These funds can be more volatile and may underperform depending on the concentration risk involved or external factors impacting their performance.

How Does Thematic Investing Work

Thematic Investing involves investing in companies that are connected to a specific theme or trend. The concept behind thematic investing is that certain industries or trends will perform well over time, and by investing in companies that are related to these themes, you may be able to achieve higher returns.

Benefits of Investing in Thematic Funds

Here are some potential benefits of investing in Thematic Funds: 

1. Exposure to High-Growth Sectors: Thematic Funds can provide you exposure to high-growth sectors poised for significant future growth. For example, a thematic fund that invests in renewable energy companies may benefit from the growing demand for clean energy.
2. Diversification: Investing in a thematic fund can provide diversification benefits to investors. These funds generally invest in a portfolio of companies related to a particular theme, which can help spread risk and reduce concentration in a single company or sector.
3. Alignment with Personal Values: Thematic Funds can also align with an investor's values or beliefs. For example, a thematic fund investing in companies focused on social impact may resonate with an investor prioritizing social responsibility.
4. Potential for Long-term Returns: Thematic Funds that have exposure to a certain industry or sector that is booming may outperform the broader market if that sector performs well in the long run. However, investors should consider their risk appetite and read all scheme related documents carefully before investing. However, it's important to note that Thematic Funds may also underperform if the theme they invest in performs differently than expected. Thus, Thematic Funds may not always give you the returns you expect.

Risks Associated with Thematic Funds 

While Thematic Funds offer many benefits to seasoned investors, they are not suitable for everyone. Here are some risks to consider when investing in Thematic Funds:

1. Concentration Risk
   Thematic funds invest in a specific sector or theme, which means they are exposed to concentration risk. If the theme underperforms or faces regulatory changes, it can have a significant impact on the fund's returns.
2. Volatility
   Thematic funds tend to be more volatile than diversified funds because of their concentrated exposure to a specific sector/theme. This volatility can lead to significant fluctuations in returns and make them unsuitable for investors with a low risk tolerance.
3. Liquidity Risk
   Some thematic funds invest in small-cap or mid-cap stocks, which may not have sufficient liquidity. This can make it challenging to exit the investment in times of market volatility or unfavourable market conditions.
4. Performance Risk
   Thematic funds can offer higher returns, but there is no guarantee that they will outperform the broader market or diversified funds. Investing in thematic funds requires a thorough understanding of the sector/theme and the underlying companies' performance. 

In order to make an informed investment decision, it is important to read the fund and offering documents carefully, especially for thematic funds. The risk-o-meter in these documents provides a visual representation of the risk level of the scheme compared to other funds. In addition, it is useful to assess the risk of the fund against relevant benchmarks or the average risk of other funds in the same category.

Takeaway

Thematic Funds has the potential to offer investors exposure to high-growth sectors, diversification benefits, alignment with personal values, active management, and potential for outperformance. However, you should carefully evaluate the risks and potential rewards before investing in a thematic fund. As with any investment, you must do your due diligence, understand the investment strategy, track record, and fees, and make an informed decision based on your investment goals and risk tolerance.

Disclaimer

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.