With 40% of last year’s equity inflows and 22% of this January’s, thematic and sectoral funds, considered among the riskiest, have become a favourite of investors. However, experts caution that many of these thematic stories may not play out the way they are being promoted.
Fund houses have been aggressively promoting thematic funds. In January, three of the 12 New Fund Offers (NFOs) accounted for over 60% of the total funds raised. In 2024, thematic funds made up around 67% of the total, with 52 of 239 NFOs falling into this category.
According to Dhirendra Kumar, CEO of Value Research, this is because investors chase recent performance and most of these funds are launched after the peak so they lose money soon after the launch. In addition, he said the distributor also gets a higher commission from mutual funds to sell the new themes.
Securities & Exchange Board of India (SEBI) chairperson Madhabi Puri Buch said on Friday that according to the regulator’s assessment, one of the factors contributing to the proliferation of thematic funds is an arbitrage between normal schemes and NFOs.
“That arbitrage took many forms and there was a perverse incentive to launch more and more NFOs in the entire ecosystem,” Buch said. “We had done a consultation paper on the same which has been approved and notified,” she said.
For this, the regulator had come up with new rules under which asset management companies will have to deploy the funds collected through NFOs within a specified time, failing that would lead to investors exiting without paying an exit load. It reduced the time earlier 60-day time period for the same to 30 days effective April 1. In addition, in the December board meeting it said that to address the issue of possible mis-selling in NFOs, for switch transactions, the distributor shall be entitled to the lower of the two commissions offered under the two schemes for switch transactions.
Mohammad Shaukat Ali, fund manager at Monarch PMS said that investors want to be a part of a story but they go overboard. While he believes that a story plays out, the valuations are extraordinary by then, he said giving the example of recent corrections in share prices of Kaynes Technology and NVIDIA.
Taking money out of other schemes to invest in thematic funds means making the portfolio concentrated. “While it may work for a high-value investor, small investors should always invest in a multi-theme approach, that is not cyclically matching,” he said.
Envision Capital MD Nilesh Shah said he is not a believer in themes. He said in a bull market few themes are created but unless you know how to enter and exit, he advises you to be diversified. Among the themes preferred by him in the current market are infrastructure, manufacturing, decarbonisation, and urbanisation.