Musical Themes Are Good, But Themed Funds Can Be Harmful for Investors

Most investors think this means these fund managers believe the theme will provide superior returns. Their enthusiasm shows in data from the Securities and Exchange Board of India (Sebi): In 2024-25, 47.3% of net inflows into equity mutual funds went into sectoral/thematic funds.

Small-cap funds saw inflows of another 7.6%. Everything else, including large cap, multi cap, flexi cap, mid cap, etc., accounts for just 45%.

How skewed this is can be seen by the fact that thematic funds represented just 12.5% ​​of equity mutual fund assets under management at the start of the year. This year’s theme has clearly been themed funds.

In the past, we have also seen a grouping of schemes around a specific theme. In 2021, for example, many Nasdaq or China/Greater China funds were launched. They all crashed the following year, with the Nasdaq among the worst-performing indexes in the world in 2022.

This is a theme (pun intended) that you would see play out every time NFOs cluster around a specific category, whether defined by geography, sector, or size (small cap versus large cap). Typically, investors lose money or underperform on these investments.

The data is simple and clear. Most themed schemes emerge at the end of the bull run for that theme.

But then, why do financing houses launch funds for themes that have already largely ended? Don’t they understand that the risks are high and that supernormal returns are unlikely?

Of course. But they also understand that you, as a retail investor, only understand this topic at this point. Maybe you even have some ‘FOMO’ (fear of missing out).

So when the scheme launches, you’re likely to participate enthusiastically, even if it eventually doesn’t end well. In short, these schemes are launched because they can pool assets for the fund, rather than optimizing portfolio returns for you.

I remember a CEO of an asset management company (AMC) being asked on a panel how he felt when his fund, which invested in a shortlist of global technology stocks and was launched in 2021, fell 37% in a year. The CEO responded that he didn’t feel anything, as he was just offering a product and it was up to the investor to decide whether to invest in it.

AMCs also launch these schemes because Sebi regulations do not allow multiple schemes by a particular AMC on the same topic. Thus, an AMC cannot have multiple small-cap schemes or multiple mid-cap schemes. But no one stops AMCs from launching funds on “new” topics.

On the one hand, NFO attracts investor interest and investment. On the other hand, Sebi regulations limit the total expense ratio of a mutual fund scheme by the size of its corpus. As an AMC’s older schemes become larger, the percentage chargeable as expenses decrease. The solution is to have some smaller funds, and NFOs achieve this.

Additionally, you should check whether the name of a schema is a good descriptor of what it actually contains. We found that value funds apply for overpriced initial public offerings (IPOs) and small-cap funds hold 10% in Reliance, which is the largest market capitalization company in India.

Many fund houses apply under very different schemes for the same IPO. One of them was applied under its large, mid and small cap schemes, as well as a tax savings scheme. Another fund requested the IPO of a loss-making company, both in terms of pension schemes and values.

The same thing happened during the IPO boom of 2021, when even value funds applied for so-called “New Age” tech companies, which might meet the criteria for a different type of fund but definitely cannot be classified as buyouts. value.

I’ve even seen green energy/ESG funds owning coal and oil stocks. This is yet another indication that most fund institutions launch NFOs or thematic funds just to pool assets.

The poor timing of most themed NFOs is one of the problems. The other part that I’ve been talking about a lot is that asset allocation determines 85-90% of your returns. When investing in a thematic fund, you are locked into your asset/sector allocation.

Furthermore, it is you who decides when to invest in a particular sector or theme. Now this is something that determines most of your returns and so if you are getting professional help from a fund manager or financial advisor, the main input they should provide is how to make tactical and dynamic asset/sector allocations. . If they leave that decision up to you, then why are you paying them?

So find a fund manager or investment advisor who will dynamically manage this allocation for you across asset classes, within stocks or across geographies and sectors – because this will determine the majority of your returns.

A tip from me: avoid themed backgrounds, at least new ones. They are almost always detrimental to the health of your portfolio.

Devina Mehra is the President, Managing Director and Founder of First Global, an Indian and global asset management company, and author of the upcoming book ‘Myths and Mantras: The Ultimate Investment Guide’. Her X handle is @devinamehra