I want to drive home one single point here. It is that investing in sector and thematic funds is as much about psychology as it is about timing. All such funds lure investors with a story. Why? It’s because the narratives are an intrinsic part of the human existence, and asset management companies (AMCs) are extremely well aware of this.
French philosopher Jean-Paul Sartre so profoundly said: “Man is always a teller of tales, he lives surrounded by his stories and the stories of others, he sees everything that happens to him through them.”
Our approach to investing is not different. That is why we succumb rapidly to the next best story. And, if we are not careful, it will drive us to invest in every single new fund offering (NFO) that promises the silver bullet to build wealth quickly. The lure of the storyline has a large influence on our decisions.
30 October 2024
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Having said that, there is a lot of money to be made if you understand the dynamics.
Entry Point Matters
In diversified equity funds, it is recommended that one invests periodically and consistently. A systematic investment plan (SIP) does that. You can invest a fixed amount at a predetermined time (daily, weekly, monthly, quarterly, semi-annually or even yearly), irrespective of the state of the market. Psychologically, this is not taxing, as the investments are automated. And you do not time the market.
When it comes to investing thematically, the most money is made when you go against the tide. You need to take a contrarian view, which is not easy.
"When it comes to thematic investing, the most money is made when you go against the tide—having a contrarian view"
When certain segments of the market are undervalued, they can throw up great opportunities, as the margin of safety is high. Margin of safety requires you to buy a stock when its market value is less than its intrinsic value. You buy the stock for less than what you believe it is worth. This acts like an insurance policy of sorts that protects you from being over optimistic.
Now apply the same to a theme. Enter during a downcycle. Do not make the mistake of entering when there is a frenzy around it.
In 2023, the public sector theme did astoundingly well, followed by infrastructure, pharma, and tech.
Here are the 1-year performance of some funds: SBI PSU (90 per cent), Bandhan Infrastructure (85 per cent), Canara Robeco Infrastructure (71 per cent), Franklin India Technology (53 per cent), UTI Healthcare (46 per cent), and so on. Now let’s consider the 10-year annualised returns of the same funds: SBI PSU (15 per cent), Bandhan Infrastructure (20 per cent), Canara Robeco Infrastructure (19 per cent), Franklin India Technology (18 per cent), and UTI Healthcare (15 per cent). I have taken the direct plans of growth schemes, and the data is as of July 30, 2024.
Over the long term, the returns of such funds are in line with those whose mandates cater to the broad market. The real money is to be made at strategic entry points as they go through the different market cycles. Enter during the downcycle and wait. That’s is where substantial money can be made.
Easier Said Than Done
As I am writing this, I am acutely aware as to how easy it sounds. But, it is not. Investing is done as much with our minds as with our emotions. We tend to move in herds.
"The falls and rallies in thematic funds can be extremely pronounced. So, stick to your investment strategy and you will benefit"
When everyone else is praising a theme, we naturally want to be part of the crowd. We don’t want to miss out. We end up jumping in when most of the returns have already been factored in. The recency bias also kicks into play. This means that we give more weight to recent events, and we extrapolate the current rally into the future, and forget that no theme or fund will always do well, every single year.
Elsewhere, no one wants to enter when it is in the doldrums, which is ironically the best time to buy.
Energy funds put up a stellar performance in 2007 with a category return of 105 per cent. Investors piled onto them (bad entry point). The global financial crisis hit the next year and the category average was -53 per cent (this would have been a good entry point). But there would be very few who would have the psychological bandwidth to get into such a fund when the sky was falling.
Or take the more recent example of PSU stocks. The Nifty PSU delivered 44 per cent in 2021, but this is after three consecutive years of negative returns. Those who entered in it during downturn would be riding a huge wave today. However, no one wanted to touch such stocks with a bargepole.
Previously I had cited the stupendous returns of infrastructure funds. Nifty Infrastructure soared from June 2006 to January 2008. Those who jumped in at that time would have lost a lot of money (bad entry point). The global financial crisis hit and it took 15 years for the index to regain its 2008 peak. A very long wait.
Hence, I reiterate my points. Investing in a thematic fund is not easy, because you need to get in when no one wants to touch it. But you have to be psychologically strong to do so and brace yourself for a deeper fall and volatility till it comes back up again.
In a broad diversified fund, there are other sectors that can provide a buffer when certain sectors slip. But this is not so in thematic funds. Hence, the falls and rallies are very pronounced and can be extremely volatile. If you can stay grounded and stick to your investment strategy, you will reap the returns.
Thematic Funds Are Not A Novel Concept
The history of sector and thematic funds goes way back to 1948, when the Chicago-based Television Shares Management Corp launched ‘The Television Fund’. This fund sought profit from the burgeoning television industry at a time when there were about 1 million television sets in the United States, and colour television was about to make its debut.
In the late 1990s, investors were enamoured with Internet stocks, convinced they would fundamentally transform the economy and allow e-retailers to take market share away from brick-and-mortar stores. In 1995, Japanese asset manager Daiwa launched the first Internet-themed fund: Daiwa U.S. Internet Open.
Such funds are now present across the globe, capturing various segments of the market—defence, media, energy, infrastructure, space exploration, innovation, robotics, genomic revolution, pharma and healthcare, banking and financial services, manufacturing, automobiles, and so on.
By Larissa Fernand, Behavioural Finance Expert
