Indian Investors Chasing Thematic Funds Amidst Market Frenzy: Experts Urge Strategic Core Building

Indian retail investors are currently experiencing a 'thematic frenzy,' pouring significant capital into sectoral and thematic mutual funds, particularly those focused on infrastructure, Public Sector Undertakings (PSUs), and manufacturing, which have shown dazzling recent returns. In October alone, sectoral and thematic funds accounted for approximately Rs 2,489 crore of the Rs 6,062 crore total New Fund Offer (NFO) collection, representing about 41% of overall inflows.

However, experts caution that this trend is largely driven by sentiment rather than strategy. Investors are often chasing short-term performance, especially after a period of flat overall market returns, hoping to capture quick gains. This behavior is concerning because data from ICRA indicates that a significant portion of these thematic funds have underperformed their benchmarks over the past year. Specifically, 80% of the top 10 funds and about 43% of all such funds failed to beat their benchmarks.

"There isn’t any fundamental shift in investor behaviour here; it’s more about sentiment. Investors tend to chase short-term performance, and that’s what we’re seeing now," notes Swapnil Aggarwal, Director at VSRK Capital.

Experts like Soumya Sarkar, co-founder of Wealth Redefine, emphasize that while these funds offer focus, their concentration in cyclical sectors poses risks, making diversification essential for long-term stability. Typically, retail investors enter these segments after a sector has already seen substantial growth, increasing the risk of buying at a peak.

In contrast, inflows into large-cap funds have declined, while flexi-cap investments are rising. Flexi-cap funds provide fund managers the flexibility to invest across large, mid, and small-cap stocks, adapting to market conditions for both growth and stability. This shift indicates a preference for dynamic strategies over static large-cap exposure, with an expectation that mid-caps and emerging sectors will drive future returns.

Recommended sectors with long-term potential include auto, consumption, banking and financial services (BFSI), and technology. However, there's an overweight allocation in PSU and defence funds, which have seen sharp rallies and may face corrections.

Key Advice for Investors:

• Build a Core Corpus First: Retail investors should only invest in sectoral or thematic funds after establishing a solid, diversified core portfolio. Manish Kothari, CEO and Co-Founder of ZFunds, suggests this should be a self-imposed criterion for investors with some experience.
• Assess Before Investing: Before entering a sectoral fund, assess its long-term potential, valuations (e.g., Price-to-Earnings ratios), sector earnings outlook, and government policy support.
• Limit Allocation: Sectoral or thematic funds should not form the core of an investment portfolio. They are tactical bets and should ideally constitute only a small portion (5-10%) of the overall portfolio that an investor is willing to risk.
• Diversification is Key: Avoid concentrating too much in one sector. Holding more than 4-5 sectoral/thematic funds can dilute returns.
• Core-Satellite Approach: Structure your portfolio like a pyramid. The broad, sturdy base (80-90%) should be diversified funds (flexi-cap, large-cap) for steady growth. The 'satellite' layer (10-20%) is for targeted bets on high-conviction themes, accepting their higher volatility. Regular rebalancing is crucial.

Impact

This trend can lead to significant losses for retail investors who chase performance without understanding the risks. Overvaluation in certain sectors due to concentrated inflows could result in sharp corrections, impacting the overall returns of those who entered late. For the broader market, excessive focus on sentiment-driven themes can lead to misallocation of capital and increased volatility. A disciplined, diversified approach, as advised by experts, is crucial for long-term wealth creation and mitigating risks. The rising popularity of flexi-cap funds suggests a maturing investor base seeking a balance between growth and stability.

Impact Rating: 7/10

Definitions

• NFO (New Fund Offer): The initial period when a new mutual fund scheme is launched, allowing investors to subscribe to its units at the face value before it opens for continuous sale.
• SEBI (Securities and Exchange Board of India): The regulatory body for securities and the mutual fund industry in India, responsible for investor protection and market development.
• AMFI (Association of Mutual Funds of India): An industry body representing Asset Management Companies (AMCs) in India, working to promote and develop the Indian mutual fund industry.
• PSU (Public Sector Undertaking): A company owned fully or partially by the government of India. PSU stocks often attract investor attention due to perceived stability or government support.
• BFSI (Banking, Financial Services and Insurance): A broad economic sector that includes banks, credit card companies, insurance companies, and investment services.
• Flexi-cap Funds: A type of equity mutual fund that has the flexibility to invest in equity and equity-related instruments across large-cap, mid-cap, and small-cap stocks, without any restrictions on market capitalization.
• Alpha: In finance, alpha represents the excess return of an investment relative to the return of a benchmark index. It is a measure of the active return on an investment, a measure of performance.
• Core-Satellite Approach: An investment strategy where a portfolio is divided into two parts: a 'core' holding of diversified, low-cost investments designed for long-term stability and growth, and a 'satellite' portion of more aggressive, higher-risk investments (like thematic or sectoral funds) aimed at generating higher returns.