Should you invest in thematic mutual fund NFOs? 6 factors to keep in mind
In 2015, ABSL Mutual Fund launched a thematic fund, providing investors a way to play the emerging ‘manufacturing’ theme. Fast forward nine years and the investors who stayed the course find the thematic fund’s 12.5% return since inception lower than the broader market return for the respective period. Thematic new fund offers (NFOs) make a tantalising proposition—targeted exposure to specific themes. But do these funds truly perform? Statistically, funds like ABSL Manufacturing that didn’t do well form 36% of the thematic NFOs launched in the past 10 years. A higher 64% have done better than the overall market since launch, an ET Wealth study shows.Game of themes
The reason for AMCs coming up with more thematic NFOs in recent years has been largely due to the regulatory cap of a single fund per category. However, funds can have any number of unique themes. Between 2014 and 2017, there were only six thematic equity NFOs (actively managed), but in the 2018-23 period, 55 new funds came into the market. Buoyant markets have helped. With equities giving double-digit returns in four of these six years, thematic funds have easily attracted eyeballs.
We compared ‘since inception returns’ of 61 thematic equity NFOs (growth-direct plans) with the respective return of BSE 500 Total Return Index (TRI). This universe manages investors’ assets worth over Rs.1.1 lakh crore today. Of the nearly five dozen funds, 39 have generated returns that were higher than the market, since launch. “The figure 64% seems like a decent hit rate in terms of thematic NFOs outperforming the broad benchmark,” says Dhaval Kapadia, Director, Head, Products, Ambit Wealth.
For the 39 funds that have beaten the respective market returns since launch, the median alpha generation is 6.2% points over BSE 500 TRI. The data is as on 4 March 2024. However, 22 thematic funds have underperformed the BSE 500 TRI, which shows that thematic NFO investing is no cakewalk. The median underperformance by these 22 funds is 2.2% points. The thematic NFO performance was pulled down by launches in years such as 2020, a difficult year for the markets, with several sectors undergoing severe stress due to the lockdowns.
According to the MF industry sources, themes for new fund launches are selected on the basis of evaluation of market dynamics, investor demand assessment, regulatory considerations and the relevant expertise of fund managers. The ET Wealth study shows that in the past 10 years, thematic funds focused on transportation, dividend yield, business cycle, manufacturing, housing and innovation have had a high share (67-100%) in terms of the number of offerings beating broad market returns since inception (see table). Most AMCs try to time the launch of a thematic NFO when the cycle is favourable. “ICICI Pru Transportation and Logistics was launched (Oct 2022) just as the theme took off. Hence, the returns (38.5%) will seem oversized. However, one down cycle can take off much of the returns quickly,” cautions Vidya Bala, Co-founder, PrimeInvestor.
Broad-based themes, whether business cycles or special situations, include a lot of sectors, and, hence, have a higher chance of performing consistently across different cycles than pure sector funds or narrow themes. Notably, only one of the three special situations NFOs have generated returns that are higher than the market, so far. The two that haven’t done well were launched in 2020.
Thematic NFOs related to ESG investing, quant investing, and consumption have 14-57% hit rate in terms of beating the BSE 500 TRI, based on ‘since inception’ returns. Just one out of seven ESG funds has beaten the broader market. “Themes such as ESG may find it difficult to beat the broad market indices in some markets as the emphasis on ‘quality’ might mean holding stocks with slightly premium valuation that can curtail the upside,” notes Bala.
AMC hit rate, investor lessons
Of the AMCs with at least four thematic NFO launches in the past 10 years, ICICI Pru (85%), Tata (67%) and Quant (100%) have tasted far more success than the others if (%) share of funds beating BSE 500 returns since respective inception period is considered.
Amol Joshi, Founder, PlanRupee Investment Services, attributes this to NFO timing, stock selection and scaling up of positions. When a theme is beaten down and about to rebound, an NFO launched around that time will do better than the benchmark as the theme takes off. “Additionally, each has followed its own specific style. For instance, one AMC (Quant) has a high churn, while the other (ICICI Pru) has followed value-based style,” says Joshi.
For investors considering investments in thematic NFOs, there are key lessons:
One, thematic funds cannot be expected to beat the market over long periods of time. Check if the theme is cyclical and decide on an entry-exit strategy. Two, don’t invest in a thematic NFO just because it is new. If the offering is indeed unique, look at how the AMC has managed close proxies. “If you are considering a new business cycle fund, look at how the AMC has managed its flexicap offering,” says Nirav Karkera, Head of Research, Fisdom.
Three, if you have a well-diversified fund portfolio, then chances are that a specific theme may already have been covered. Four, check your existing net sectoral exposure via MFs and stocks before going for a higher allocation to certain sectors via a thematic NFO. Five, AMCs come out with thematic NFOs when the theme is well into its cycle. So, check whether enough upside potential is left when you enter.
Six, thematic investing is for nuanced investors wanting to allocate a small proportion of their portfolios tactically. They cannot account for a chunk of one’s portfolio.
This story originally appeared on: India Times - Author:Faqs of Insurances
