
- Large Caps
- Mid Caps
- Small Caps
- Multi Caps
- Large & Mid Caps etc.
Very rarely has there been enough discussion on Thematic and
Sectoral Mutual Funds and we will try to rectify the same via this article.
What is a Thematic Mutual Fund?
- A Thematic Mutual Fund as the name suggests follows a particular theme when investing.
- A Thematic Mutual Fund can invest across various sectors that fall within one particular theme.
- It is far more diversified than a Sectoral Mutual Fund since it is not restricted to any one particular sector.
What is a Sectoral Mutual Fund?
- A Sectoral Mutual Fund as the name suggests invests only in one particular sector.
- It is less diversified than a Thematic Mutual Fund since it is restricted to just one particular sector.
You may be able to understand this better by reading the
following example.
Think
of Sports as a theme and various disciplines like Football and Basketball like
sectors. Sports constitute both Football and Basketball but Football does not
constitute Basketball and Basketball does not constitute Football.
In the same manner a Thematic Mutual Fund constitute various
sectors but it is not necessary that various sectors fall within the same
theme.
Thematic Mutual Fund and Sectoral Mutual
Fund (Portfolio Allocation)
Thematic Mutual Fund
The table below mentions the top five holdings of Franklin
Build India Fund (Thematic) as on 31th January 2019
Holding
|
Category
|
State Bank Of India
|
Banks
|
HDFC Bank Ltd.
|
Banks
|
Indian Oil Corp Ltd.
|
Energy
|
Bharat Petroleum Corp. Ltd
|
Energy
|
NTPC Ltd.
|
Utilities
|
The picture below showcases the top five sectors it was
invested in as on 31st January 2019
As you can see from both the table as well as the picture,
there is diversification in the holdings as well as the sectors. But what needs
to be understood is that this diversification takes well within the realms of
the theme (Infrastructure) and not beyond.
The Fund is not dependent on any one particular sector as
such. This allows the Fund Manager to diversify risks which is extremely
beneficial in case any one particular sector is going through a lean phase be
it due to any new policy, market conditions or even regulatory changes like in
the case of Pharmaceutical companies.
Sectoral Mutual Fund
The table mentions the top five holdings of Reliance Pharma
Fund (Sectoral) as on 31st January 2019
Holding | Category |
Divi’s Laboratories Limited | Pharmaceuticals |
Sun Pharmaceutical Industries Limited | Pharmaceuticals |
Aurobindo Pharma Limited | Pharmaceuticals |
Dr Reddy’s Laboratories Limited | Pharmaceuticals |
Sanofi India Limited | Pharmaceuticals |
As you can see all the top five holdings belong to the same
sector.
- With Pharmaceuticals based Mutual Funds, they are not only affected by domestic issues but also international issues.
- A Pharmaceutical company in India has to take into account not only Indian regulations but also US regulations. This is because the US is the largest pharmaceuticals market, for Indian companies it makes up 40-50% of revenues.
- Since Indian pharmaceutical companies form more than 1/3rd of the US pharmaceutical sector, it is bound to attract greater inspection than the rest.
- This would require a more robust system on the part of the Indian Pharmaceutical companies in order to get the necessary clearance from the US FDA (Food and Drug administration).
- Domestically Indian Pharmaceuticals suffer the dual setbacks of tax policies and price cap. The latter is due to the government wanting for cheaper drugs for the general public at large.
When are Thematic and Sectoral Funds launched?
It is generally seen that a Fund House would launch a scheme
if it does not currently have one in a category. With SEBI not permitting a
Fund House to have more than two schemes in the same category, the timing of
the launch becomes all the more important considering that major business is
expected and driven during a NFO.
With Thematic and Sectoral Funds though, the timing of them
is very much dependent on the narrative that is propounded.
- The reason for all these Funds being launched between 1998 and 2000 is because this was supposed to be the time of the IT boom in India.
- The IT sector in 1998 contributed 1.2% to India’s GDP. The TIDEL Park, the then largest IT park in Asia was opened in the year 2000.
- The Information Technology Act was also passed in the year 2000 which paved the way for legal procedures for electronics transactions and e-commerce.
- All of the above factors did help in creating a positive market environment for the IT sector to boom and various AMC’s were not going to be left behind to milk this.
- This therefore led to the launch of several IT based Mutual Fund Schemes in the space of just 2 years.
- We have thus seen how the positive scenario around one particular sector helped in driving investors towards a particular Mutual Fund Scheme.
Now let’s look for an example where a beaten down sector
allows for business to thrive in a particular sector driven Mutual Fund scheme.
Scheme Name | Launch Date |
DSP Healthcare Fund | Nov-18 |
ICICI Pharma Healthcare and Diagnostics | Jul-18 |
IDBI Healthcare Fund | Feb-19 |
Mirae Asset Healthcare Fund | Jul-18 |
All of the above mentioned schemes were launched within a
space of just 8 months.
The reason for this is that the Pharmaceutical sector as a
whole was down, this therefore paved the way to build up a consensus that the
past is behind us and things will only get better from here on.
As mentioned above, the timing of the launch of these types
of schemes is very much dependent on the narrative that one wishes to believe.
How do Thematic and Sectoral Funds differ from other
equity funds?
When it comes to Large, small, mid, multi, focused, large
& mid-caps there is no restrictions of sectors. Sure there is restriction
that comes with minimum investments in categories but not in sectors.
Large Cap Fund
For example a Large Cap Fund is required by law to invest a
minimum of 80% in large cap stocks. But these large cap stocks need not be
confined by sectors, meaning these large cap stocks can vary from banks to
financial services to oil. The only restriction is that it should be a large
cap stock.
Focused Fund
This is also the case with a Focused Fund, even though the
Fund will invest only in a select number of stocks, it is not confined by the
sectors. For example if a Focused Fund is limited by say only 25 stocks, it
will not be restricted with the sectors that these funds belong. So it can
swing with ease between various sectors as long as the number of stocks is not
exceeded.
Sectoral Fund
With a Sectoral Fund, it is mandated to invest in that
particular sector itself. This therefore does not allow it to take refuge in
other sectors in case the sector it is currently invested in seems overvalued
and due a correction.
Thematic Fund
With a Thematic Fund like say an Infrastructure Fund, a
regulatory change in sector will have an effect on another sector too since
they are all interlinked. For example a rise in cement prices will affect the
real estate sector and thereby residential home prices.
Large & Mid Cap Fund
When you consider a Large & Mid cap fund, the minimum
allocation in both the large and mid-sectors is 35% but the remaining 30% is
entirely at the discretion at the Fund Manager. If the Fund Manager feels that
the market is overvalued he/she can allocate the remaining 30% to large cap
stocks, if however he feels there is further scope for growth then he/she can
allocate the remaining 30% to mid-cap stocks.
The point of the above Large& Mid cap Fund example is to
demonstrate the flexibility a fund manager enjoys when it comes to other equity
funds that he/she does not have with thematic and sectoral funds so therefore
they tend to be very high risk.
These Funds also tend to have an extremely high portfolio
turnover ratio which is a determinant of the number of times a portfolio has
been churned (movement)
Scheme | Turnover Ratio |
ICICI Banking & Financial Services Fund | 168% |
SBI Banking & Financial Services Fund | 175% |
Taurus Banking & Financial Services Fund | 114% |
Source: Factsheet February 2019
A turnover ratio of over 100% means the portfolio has been
completely changed over a period. The reason for such high turnover ratios with
thematic and sectoral funds is because they tend to invest in businesses and
sectors that are cyclical in nature, meaning the fund manager strives to enter
at a low and exit at a high.
When should you Enter and Exit in Thematic and Sectoral
Funds?
- When you enter and when you exit a thematic and sectoral mutual fund is extremely vital. This becomes all the more important when it comes to a lump sum amount (Which should be avoided in most cases).
- The reason for this is that these funds invest in cyclical businesses and ergo they themselves are cyclical funds. Take the example of real estate, you must have often read or heard the real sector is down or the real sector is booming.
- This is not to say that other equity funds do not have their own volatility but with thematic and sectoral funds, volatility is more frequent and at a higher level.
- If you enter a thematic fund at a high and exit at a low then the entire exercise was futile. This means you cannot have a strict timeline with these funds, you cannot pick a year when you enter and a year when you exit. You would need to be extremely flexible and clever with your timing of entry and exit in these funds.
- Keep in mind that the fund manager has his/her own strategy in place for entry and exits, if your timing does not align with that of the fund manager then that is a cause for major worry.
- You cannot predict the actions of the fund manager, that is beyond your control but what is within your control is your actions. So the prudent thing would be to leave timing completely up to the manager when it comes to the fund portfolio, you would still need to take your own calls with your own portfolio.
- One of the biggest blunders that investors commit with these funds is looking at past returns and investing blindly expecting the markets to continue with its upward trend. When the markets slide investors exit with a heavy loss since they entered at a market high and exit at a market low.
- This process of entering with greed and exiting with regret is very common and will continue as long as investors look at their portfolio with goals and not desire.
Should you invest in thematic and sectoral mutual funds?
- These funds should never be a part of your core portfolio. Your core portfolio is the major chunk of your overall portfolio which would mean a rise or drop in them would be significant. Your core portfolio should only constitute moderately aggressive schemes and not very high risk schemes. The foundation of your portfolio cannot be so unstable and built on such shaky grounds.
- The only reason to pick these schemes is when you are sure all other areas have been adequately covered and there is still scope for diversification. In an ideal world these schemes should rarely be part of most investor’s portfolio and yet when you look at the AUM some of these schemes have garnered, it is reflective of the returns chasing investor rather than the goal oriented investor.
- It should not take up more than 10% of your entire portfolio and that too should have a valid reason.
Another thing to ponder on is whether the scheme you would
be venturing in to has been adequately covered or not. Take the case of A
Banking and Financial Services themes fund.
- We have taken the example of one scheme each from a Focused, Multi Cap, Large Cap and a Large & Mid Cap. The reason being schemes of these categories more or less form the core portfolio of the average investor (Large & Mid Cap in lesser proportion).
- The contribution when it comes to Banking & Financial Services in these schemes is between 30 to 45 % which means 1/3rd of the entire portfolio is invested in stocks of this sector.
- When you compare a Banking & Financial Services with one of the above mentioned schemes, you would realize there is a high level of overlapping in stock selection. This would defeat the purpose of having a separate banking and financial services fund.
- This is not to say that all funds of the above mentioned categories do take a higher proportion to banking and financial services but you would struggle to find a large or multi cap fund without exposure to HDFC Bank and Bajaj Financial Services.
- This overlapping in stock selection defeats the very purpose of having a diversified portfolio.
Between the following, which scenario sounds more risk
efficient?
A) Having a diversified portfolio
with meaningful exposure to banking and financial services or
B) Having a strictly banking and
financial services based fund?
In scenario A the fund manager can enter and exit as and
when he feels it is needed but the same cannot be said of scenario.
Your reason to invest in a thematic or sectoral mutual fund needs to be
backed by logical reasoning like having no exposure at all or minimal in your
portfolio and you have the requisite skills to understand the sector well
enough to time your entry and exit or else you are better off without such funds.
For portfolio enquiries, email us with your doubts at info@themutualfundguide.com
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