Thematic Funds – How They Work? And How To Invest?

Are you an investor? Do you also chase blatant trends in the investment market? Investment in thematic mutual funds should be your mantra.

 There may be better approaches to investing in thematic funds.

Jack Kerohouac once said

that those who yield to trends, fads, and popular opinion do not accomplish great things. 

Why am I saying this? 

Courtesy, the trends in the US money market. In the FY 2024-25, around 1/3rd of Americans invested in thematic and sectoral funds. 

That said, most money was channeled to the trending themes and sectors. 

The bottom line is that most investors must focus more on chasing market trends. 

Defining Thematic Funds

Thematic funds are a kind of mutual funds. Now, are they compatible with Liquid funds, too? 

The question arises as most investors are hooked on short-term trends while investing in thematic funds.

But that’s not the right approach, as I said. For thematic investments, the right strategy would be pursuing market exposure. That would spawn unique investment ideas/plans. 

For instance, a fund based on the architecture theme would attract investments into iron and steel, construction, cement, and other such firms.

How do Thematic Funds Work?

Thematic funds are mutual funds. Again, all mutual funds are linked to underlying assets. These assets beget returns from the money market. 

However, thematic funds may be multi-cap funds, too.. Read What is Multi Cap Mutual Funds & Its Types To understand better. The trend matters more than the pattern of maturity tenures of the fund. 

I observed that many thematic funds are large-cap funds in reality. Their linked assets are the stocks of the most reputed brands/accomplished firms in the US market. 

Investing in such firms can be a theme. 

Another theme may be investing in industry clusters. 

Similarly, thematic funds may be the stocks of companies clubbed by a cluster. For example, the architecture sector, foods and beverages, FMCG, and other such clusters (sectors). 

How do you operate thematic funds?

Follow the sequence below to understand how thematic funds operate.

1. Theme Selection

You select the theme or trend with the potential to offer long-term growth. However, don’t be a sheep in the market. Do exclusive research to understand if the theme is worth the hype. 

Organic research often lets you discover latent prospects in a theme, too. 

2. Stock Selection

After setting the theme, it is time to identify the criteria for mapping companies. For example, selecting construction sector companies with high credit quality helps your cause. 

Similarly, other criteria may also be noteworthy here. 

For instance, growth potential and market position can be other trend-setting factors, too. 

You may pick the companies with good growth potential, too. It would work out, even if the company has low to moderate credit quality. 

I checked a recent listing on US News to find out that BTC and AIQ can be two potential stocks in the US market. 

3. Building a credible portfolio

At this stage, you have created a portfolio of funds that fit the criteria of your theme. 

Like debt funds, your portfolio for thematic investments should be diverse, too. 

Debt funds are, however, long-term funds mainly. To learn more about debt funds, read Debt Fund Definition, Risk, How to Invest, Examples.

4. Manage your portfolio actively

Are you a good fund manager? Then, you should have the ability to micro-manage your funds.

The crux of active management is monitoring how investments in your portfolio work out. 

If your portfolio does not match the theme’s dynamics, you can adjust the funds promptly. 

However, you must continuously check your credit reports to update your portfolio. Find out the areas where your portfolio may improve. Read more about Credit Reports: What Are They And Where Can You See Yours?

5. Evaluating Performance

The thematic funds are akin to Liquid funds in many ways. Like liquid funds, they follow benchmarks set by various indices to measure success. 

6. Risks and Other Contingencies

If the theme succeeds, your fund will do good, too. At the end of the day, the market factors and regulatory changes are what matter.

The success of the funds depends mainly on these aspects. 

Pro Tip: thematic funds have a specific focus. Hence, it is prone to volatility. 

Why should you invest in thematic funds?

There are several benefits of investing in thematic funds. Let’s follow up with the most important ones. 

1. Portfolio diversification

Thematic funds mainly emphasize one sector only. However, you can follow multiple successful themes. Thus adding diversity to your investment portfolio. 

If one sector performs below the mark, other investments can complement it. 

2. Creating a source of long-term returns

If companies grow, the value of their stocks will also increase. As an outcome, your returns will be higher. 

Compared to traditional bonds, these high-yielding bonds are better for your profile. 

Thematic mutual funds can adapt to dynamic market trends, too.

If you are investing in these trending companies, your growth potential will improve. 

The emerging technologies and industries associated with them will witness high growth potential in the US. 

These trends can be apt for your current profile. But you should be wary of the mutual fund investment risks, too. 

3. Making informed choices

If you know the nooks and hooks of the market, then thematic funds are for you. 

Informed people can discern risks and opportunities across sectors. 

Hence, you can leverage your existing knowledge to improve the returns from your investments. 

Related Risks

No fund is risk-free, whether a thematic fund or Ultra-short-term funds. What are the potential risks bound to thematic funds?What Are Bond Funds? A Complete Overview

1. Price Risk

Thematic funds are volatile, as market factors are involved. Popular industry trends or economic factors might impact returns from thematic funds. Hence, the fund’s value may fluctuate. And it will affect the returns indirectly. 

2. Liquidity Risks

Some industries may have a low trading volume. The sector may face some temporary hurdles related to buying and selling funds. Hence, the investor returns may be hit. The fund’s performance can also go down. 

3. Event Risk

Event risks firmly impact thematic funds. Issues like technical lags, regulatory issues, or global political incidents may affect your chosen theme. So, be careful of these two factors while investing in thematic funds. 

How do you invest in thematic funds?

Some subtle and other apparent rules govern thematic investing. 

I suggest discovering new trends and opportunities to invest in. Search at least 10 to 15 themes to get started. 

However, there’s a catch. Don’t invest in trends that run the market. Instead, engineer your organic research and find out selective stocks. 

1. Discover a dynamic range of themes

Diversify your theme choices. Begin by scanning the popular sectors. AI and alternative energy stocks are the most popular in the US now.

So, themes related to these sectors may boost the returns from your investments. 

You may also uncover new sectors from your research. Often, a sector may have low credit quality at present. However, check its growth potential as a firm. Check the growth potential of other firms in the industry. 

2. Using credible sources to pick the best themes for you 

Many firms can help you with your organic research across sectors and industries. Schwab.com is such a tool. It lets you surf around 40 popular and prospective themes across multiple niches. Their proprietary technology may assist in discovering trends and patterns to make an industry favorable. 

It also helps you to group options into themes. 

There are other ways of investing in thematic funds, too. You can urge your DP or broker to dilute your funds across more mutual funds. At the same time, you can also invest through SIPs. 

Pro Tip: Thematic funds are theme-based. Aligning with more than one theme also poses a significant risk. 

As a single theme picks selective stocks for you only, it causes diversity lag. 

Indeed, the selected stocks will have the highest returns. However, you would be at grave risk if your stock portfolio doesn’t click. 

Conclusion

The thematic funds are more refined funds to improve the chances of higher returns. 

However, themes don’t necessarily need to make your profile stagnant. Instead, you can constantly rotate your themes within your portfolio. 

Let not market trends dominate your stock selection. At the same time, choose stocks with greater conviction around them. And deter those with less support from the market. 

Use your research or a tool to optimize your forecasts for the future. Lastly, remember that an emphasis on risk management must follow a diverse investing approach.

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