Thematic investing: Is it for you?

Every stock market rally has some theme or the other. It is some overarching narrative that propels benchmark indices beyond a threshold into the unknown ’all-time high’ territory. Then there are investors and money managers who want to take a sliver of the larger narrative that is pushing the markets higher and find smaller pockets they can profit from. That in essence is what we call thematic investing.

Some of these could be the more significant ones like the theme of the transition to clean energy from conventional, the China+1 policy of many American and European companies, the switch from fossil-fuel-based mobility to electric mobility, the transition to renewable energy to produce power, and others. Most of these are monumental shifts that are happening all over the world and will take a few more years to pan out.

In India, there are other enduring themes that investors latch on to, like a sectoral mutual fund scheme–like an IT sector fund, pharmaceuticals fund, non-discretionary fund, and others. Such mutual fund schemes attempt to make concentrated bets on themes/sectors. PMS and AIF schemes that allow investors to make thematic investments.

If you invest in a theme, you are making a concentrated top-down bet. Is that always a good thing?

Diamonds are forever, but not all themes

Let’s take the example of India’s IT or technology sector. Currently, 15 sectoral funds invest in India’s IT sector and two more are on the way. These are active and passively managed funds with an AUM of Rs 28,061 crore as of May 31, 2023. That’s around 15.4% of the total AUM of sectoral/thematic funds in India.

A few of these schemes are long-running, and many came up in the past few years. This was because IT services was the buzzword after the pandemic broke out in 2020. After the initial fall in stocks of IT services companies, the expectation of rapid revenue growth because of remote work worldwide led to a surge in demand for IT services.

That trend, however, ended around Q1FY23.

From April 1, 2020 to March 31, 2023, Nifty IT gave returns of nearly 25% annually. The top of Nifty IT was in January 2022, after which it has been moving sideways. That brings us to what happened in January 2022.

Well, the US Federal Reserve said it would do whatever it takes to control inflation. This pushed many companies across the world to reevaluate their budgets as cheaper loans would get more expensive.

This led big technology spenders like banks, retail companies, and pharma companies to curtail their tech spending, resulting in the current downturn in IT stocks.?

So is thematic investing bad?

The answer to that question is a resounding NO. Don’t underestimate the emphatic nature of that statement.?

Returns will be made in thematic investing, but you should know what you are doing. Whether thematic investing suits you is up to your own risk appetite and whether you understand what you are doing. In most cases, some folks either don’t cash out at the top (timing the market?) or don’t understand that some themes can be short cyclical bets.

That might sound like timing the market, contrary to our exhortations of not trying to time the market. Well, not timing the market is for people who don’t want to complicate their lives by tracking every second of the stock market’s movements.?

If you have an advisor who can guide you through the suitability of such thematic investments, you can understand your thematic investments better and when to book your profits. So, as always, consult your advisor before making any investment decisions.