Thematic investing: For the informed lot

Recent correction in the markets has rubbed investors in thematic offerings of the mutual funds on the wrong side. These have fallen more than the broad markets represented by indices such as the Nifty 50 or the Nifty 500. Many fund houses launched schemes around themes such as manufacturing and business cycle over the last one year and investors have aggressively invested in these. Most of the incremental equity inflows went into these schemes over already existing diversified equity schemes. As net asset value (NAV) of these newly launched thematic schemes erodes, some investors, especially the first-timers frown. However, this may be too early to react. Rather than reacting to such short-term moves, investors need to take stock of the situation.?

Here are a few things they should bear in mind:?

Know a theme?

Most investors find it difficult to invest in risky assets such as equities. Thematic investing has the potential to bring in incremental returns but entails incremental risks. Thematic investing is like riding a young horse. The rider needs to know horse-riding well otherwise it can be an unnerving experience.?

Some of these themes are secular in nature. For example, consumption is one such theme which is driven by increasing income calling for increased consumption demand. This may be an irreversible trend and may play out over a long period of time – may be a couple of decades. However, there are a few themes which are driven by certain policy decisions such as infrastructure and manufacturing. Government’s policy framework wants to put India on the global manufacturing map. Production linked incentives and other targeted measures to enhance local production facilities to export more and cater to local demand can be a big game changer for manufacturing companies in the long term and for the capital goods companies in the short to medium term. No wonder we have seen a strong surge in prices of shares of companies operating in this segment.?

Markets discounts the future?

Though themes are expected to play out over the long term and reward investors, the pace at which the execution takes place may change. Market participants however prefer to discount the future. We have seen that playing out in our financial markets. We expect India to emerge as a meaningful player in the manufacturing sector in the next five years. However, the markets towards the end of the FY2024, had ascribed valuations to stocks factoring in the future growth. No wonder, when slowdown in earnings hit corporate earnings, correction was seen more in thematic stocks where the valuations were stretched. These stocks fell more than the broad markets.?

Investors must understand that this is not an anomaly. These adjustments keep taking place in the markets. Valuations run ahead of fundamentals and then either fundamentals have to catch up or stock prices need to correct. Slowdown in economic activity caused by elections and monsoon has led to slow ordering of new projects. Besides this, there has been incessant selling by foreign portfolio investors as they were keen to re-allocate their resources to the US equities. No wonder, we have seen a setback to thematic investing.?

Themes bounce back?

A pull-back need not necessarily mean a prolonged bear market or an end to the growth offered by an investment theme. Themes do bounce back. For example, the infrastructure theme started playing out after the NDA government came to power. The real recognition was seen in the bull market of 2003-2007. However, it fizzled out after the change in the government policies. It came back to limelight after the Narendra Modi-led NDA took over in 2014.?

Investors must understand that even secular themes such as consumption also see slowdown. For example, discretionary consumption has done well over the last three years due to premiumisation and increased high-ticket spending despite the fragile nature of the economy immediately after the Covid-19 pandemic. However, in the recent past we have seen fatigue setting in and slow down in key sectors such as automobiles. As interest rates are expected to go down early next year, consumption may come back with full vigour.?

In this backdrop, investors must remember that thematic investing is all about looking at a broad trend for the long term. The best strategy is to keep monitoring the trend and keep feeding it from time to time. Investors must figure out if they are convinced with the long-term nature of an underlying theme and the drivers supporting its potential growth. If they understand the risk-reward or have access to quality investment advice, then they should hold on to their investments. They should also add on to the investments on corrections to benefit in the medium to long term. However, it makes sense to stay invested in diversified equity schemes for investors who may not be comfortable investing in thematic schemes.

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Disclaimer: This report is prepared in his personal capacity and neither the Author nor Money Honey Financial Services Pvt Ltd assumes any responsibility or liability for any error or omission in the content of the article. Investments in mutual funds and other risky assets are subject to market risks. Please seek advice from an investment professional before investing.

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