Are Thematic Funds Losing Their Charm? Experts Urge Caution Amid Market Volatility

Market Correction Hits Thematic Investments, Raising Concerns Over High-Risk Exposure

Mumbai, March 4, 2025 – The once-booming thematic investment segment is witnessing a significant slowdown, with returns taking a hit amid increased market volatility. Experts now warn investors—especially newcomers—to tread carefully when considering thematic funds, as these high-risk investments have struggled to outperform broader market indices in recent months.

The latest data from Value Research reveals that while thematic funds delivered 15.13% returns over three years and 19.54% over five years, their performance has deteriorated sharply in recent months. The segment has fallen 14.52% year-to-date (YTD) and nearly 10% in the last one month, significantly underperforming broader indices such as the BSE 500.

Adding to concerns, flows into thematic funds dropped to ₹9,000 crore in January, down from ₹15,322 crore in December, according to Association of Mutual Funds in India (AMFI) data. Market observers note that this could signal a shift in investor sentiment, but a clearer picture will emerge after analyzing February and March trends.

Thematic Investing: A Risky Proposition for New Investors?

Thematic investing focuses on specific industry trends, emerging sectors, or macroeconomic themes, making it highly sensitive to market fluctuations. While some themes—such as banking and pharmaceuticals—have demonstrated resilience, broader thematic categories have been hit hard in the recent correction.

Juzer Gabajiwala, Director at Ventura Securities, highlights that many IPOs and New Fund Offers (NFOs) launched in the thematic space have struggled to deliver returns. He advises against investing in thematic funds at this juncture, stating:

“The current market conditions do not justify thematic investments. Instead, investors should consider multi-cap funds, which offer diversified exposure with lower risk.”

Similarly, Shweta Rajani of Anand Rathi suggests that investors looking to enter thematic investing should opt for broader themes that resemble diversified funds, as they offer exposure to multiple sectors rather than being concentrated in a single industry.

“A broad-based thematic fund provides a safety net in volatile markets. Unlike narrowly focused thematic funds, they can mitigate risks by diversifying across multiple industries,” she explains.

Thematic Funds vs. Diversified Funds: A Performance Check

The long-term performance of thematic funds has not consistently outperformed diversified mutual funds, raising concerns about their viability in uncertain market conditions.

• Higher Short-Term Risk: Thematic funds are prone to extreme volatility, as they rely on specific trends that may not sustain in adverse market environments.
• Underperformance in Market Corrections: The recent correction has disproportionately impacted thematic investments, with several funds recording double-digit losses in just a few months.
• Limited Long-Term Value Addition: Data suggests that while thematic funds may generate short-term alpha, they rarely outperform diversified funds over longer investment horizons.

“The current returns on thematic funds are quite poor, and data shows that they do not add substantial long-term value,” Rajani asserts.

Given this, financial experts emphasize the importance of portfolio diversification rather than concentrated investments in thematic funds.

Regulatory Scrutiny on Thematic NFOs: A Necessary Step?

A recent Moneycontrol report suggests that the Securities and Exchange Board of India (SEBI) is considering tighter regulations for thematic NFOs. Concerns have emerged that thematic funds are being launched primarily to attract investors to new schemes rather than offering genuine differentiation.

Market observers note that many AMCs use thematic NFOs as a marketing tool, often leading to mis-selling and confusion among retail investors. Unlike other mutual fund categories that have strict investment limits, thematic funds remain largely unrestricted, which raises concerns about investor protection.

“If other categories have regulatory constraints, thematic funds should not be open-ended without oversight. Many NFOs are simply repackaged versions of existing funds,” Rajani states.

With 80-90% of new fund launches in 2024 being thematic-based, the segment has seen significant inflows, but analysts expect allocations to decline as NFO activity slows down.

Active vs. Passive Thematic Funds: Which is Better?

Another debate in the thematic investing space is whether active or passive thematic funds offer better value.

Rajani argues that active thematic funds are preferable, as they allow fund managers to adjust portfolios in response to changing market conditions.

“Passive thematic funds rebalance every six months, which may not be ideal in a dynamic market. Active funds offer better risk management and flexibility,” she explains.

However, investors must assess fund manager expertise and historical performance before investing in active thematic funds, as poorly managed funds can lead to significant losses.

What Should Investors Do?

With thematic funds facing headwinds, financial advisors recommend a cautious approach:

1. Prioritize Diversification: Multi-cap and flexi-cap funds provide broad market exposure with lesser volatility compared to thematic funds.
2. Focus on Established Sectors: If investing in thematic funds, opt for sectors with long-term growth potential, such as banking, IT, and pharmaceuticals.
3. Avoid Short-Term Speculation: Thematic funds often appeal to investors looking for quick gains, but their performance can be highly unpredictable.
4. Assess Regulatory Changes: The SEBI’s regulatory stance on thematic funds may impact future fund launches and performance.

Is Thematic Investing Losing Its Appeal?

While thematic investing continues to attract attention, its high-risk nature and recent underperformance suggest that investors should exercise caution. With regulatory scrutiny increasing and market sentiment shifting, the future of thematic funds remains uncertain.

As Rajani concludes:

“Thematic funds can offer exciting growth opportunities, but they require a deep understanding of market cycles. For most investors, diversified funds remain the safer and more reliable choice.”

Given the current landscape, investors should evaluate their risk tolerance carefully before venturing into thematic funds, ensuring that their investment choices align with long-term financial goals rather than short-term market trends.