At the end of the day, the bet may or may not play out, depending on how the sector or theme performs.
The USP of thematic funds is that if a sector or theme looks promising, or is in vogue, and the fund manager has a proven track record, the chances of making outsized gains are rather high. At the same time, it is also about the investor’s conviction in the idea (sector) and the fund manager. In a way, this is a concentrated bet, as it is about a particular investment theme, even though the fund may be well-diversified in terms of number of stocks.
However, at the end of the day, the bet may or may not play out, depending on how the sector or theme performs. Also, the role of the fund manager is limited by the scope of investment.
It is due to these factors that the performance of sectoral or thematic funds is more dispersed compared to other fund categories.
Let us look at some performance data.
As of December 24, 2020, a basket of 27 large cap funds (regular option) delivered an average five-year return of 10.8 per cent, with the best-performing fund delivering 14.9 per cent and the worst-performing being at 6.6 per cent. In effect, the range between the best- and the worst-performing funds is between 14.9 per cent and 6.6 per cent.
Now, comparing this with a diverse basket of 67 sectoral or thematic funds, the five-year return till December 24, 2020 showed an average of 9.5 per cent (a little lower than the average of large-cap basket). The best-performing fund here generated a return of 18.7 per cent, and the worst-performing one logged a negative return of 2.9 per cent. So, the performance range here is between 18.7 per cent (higher than large cap) and negative 2.9 per cent (much lower than 6.6 per cent).
Some may argue that the comparison of thematic funds with large-cap funds is not fair. In that case, instead of large caps, let us consider multi-cap funds.
Till December 24, 2020, the five-year average return from a basket of multi-cap funds showed an average of 10.8 per cent (similar to large cap), the best-performing fund generated 14.9 per cent (again similar to large cap) and the worst-performing fund generated 5.6 per cent (a little lower than large cap). Here also, the five-year performance range is between 14.9 per cent and 5.6 per cent, whereas in case of thematic funds, the performance range is between 18.7 per cent and negative 2.9 per cent. Such wide disparity in performance is one of the side effects of playing a particular sector or theme.
If we take a look at the best- and the worst-performing thematic funds for clues as to which idea has done well, there too the dispersion is high. Over a five-year period, the five best-performing thematic funds are Aditya Birla Sun Life Digital India Fund (CAGR 18.7 per cent), ICICI Prudential Technology Fund (18.6 per cent), SBI Banking & Financial Services Fund (17.6 per cent), Nippon India US Equity Opportunities Fund (16.7 per cent) and ICICI Prudential US Bluechip Equity (16.2 per cent). The theme here ranges from IT to financial services to US equities.
In the same period, the ideas that did not work include HDFC Infrastructure Fund (CAGR of minus 2.9 per cent), HSBC Infrastructure Equity Fund (minus 1.3 per cent), SBI PSU Fund (0.6 per cent), UTI Transportation and Logistics Fund (3.3 per cent) and Canara Robeco Infrastructure Fund (4.7 per cent). In hindsight, the infrastructure or PSU themes did not play out over the last five years, but whether the same will be true over the next five years is anybody’s call.
Given this backdrop, it will help if in a thematic fund, the fund manager is given the flexibility to play on ideas which are model-driven coupled with judgement. Currently, ICICI Prudential Business Cycle Fund offers such an idea for which the NFO is currently underway. This fund has the flexibility to invest across market caps, themes and sectors, thereby giving the fund manager a wide canvas.
Here, the fund manager will be identifying themes and sectors based on a prevailing business cycle (growth, recession, recovery etc.). During a particular phase, say growth or recovery, certain sectors tend to do well, and this fund can go overweight on those sectors. The universe being Nifty 500, the portfolio can be evenly spread across say 4-6 sectors, or can be concentrated to 2-3 sectors, based on signals as per the business cycle model. The concept is in a way similar to that of BAF funds, where you don’t have to worry about the allocation to equity and debt. The investor is relieved from making the decision to toggle between asset classes and taxation issues.
The other route to play the market theme is through the index funds or index ETFs of certain sectors. The important point to remember here is the onus of rejigging the sectors will depend on the investor, whereas in the fund mentioned above, the fund manager will do the needful for the investor. The other moot point of difference one has to be cognizant about is that index composition gets revised periodically, both in terms of constituents and floating-stock weightage, which varies as per prices. This is a reactive process as the revision is based on the past facts. For a forward-looking play, the optimal still is to invest through conventional mutual funds.